How can I incentivise my key staff?

One of the biggest headaches of an entrepreneur is building and retaining a great team, who understand your vision, and are able to consistently deliver what and how you want them to. Whilst there are lots of opportunities here, the focus of this article is shares. This is because they can be a way to bring the long-term objectives of employees and employers into line.

There are several reasons why an employer would provide shares or the option to purchase shares to their employees. They can include:

• Aligning employee and business objectives;
• Attracting and retaining key employees;
• Incentivising employees to encourage enhanced performance, in potentially tax efficient ways;
• Raising equity funding, especially in Management/Employee buy-outs; and
• Succession planning for the business.

If the shares are given outright to the employee, the employee will have a taxable remuneration on the difference between the market value of the company’s shares, and the price (if any) paid. Share options can therefore be more tax efficient.

There are four key ways of offering shares or the option of shares to employees, each of which are explored further below. The first three involve the use of share options; the final one involves the employer giving a fixed number of shares free of tax and National Insurance (‘NI’).

1. Approved Share Option Scheme (‘CSOPs’)

Company Share Options Schemes or CSOPs are approved share options schemes. They require HMRC approval and as such must fall within the HMRC guidelines. They are particularly suitable for family or owner-managed companies because only selected employees need be included, where the employees work at least 25 hours a week, and do not have more than 25% share capital.

They operate by granting the participants options to purchase shares in the company at a later date, but at a fixed price from the outset (usually the market value of the shares at the date the options are granted).

The options can be exercised between three and ten years after being granted and can be made dependent on specific performance targets, but cannot exceed £30,000 in value (based on the share market value at date options were granted).

In terms of tax implications:

• Employee: there is no income tax (‘IT’) or NI when they are granted or when exercised (unlike unapproved schemes). On disposal there will be IT on the Capital Gain (‘CG’) at 10%/20% (i.e., disposal proceeds less the price paid when the options were exercised).
• Employer: Company will receive a corporation tax deduction, on exercise, of the difference between the market value of the shares less the price paid by the employer for the shares.

In addition to our fees, the legal costs of setting up these schemes start from around £1,000+VAT, but can quickly get significantly more expensive, depending who they are offered to and how complex the terms are. They are therefore more common for larger limited companies. We are happy to make referrals here to Strategic Partners we work with on a regular basis, if this would be helpful to you.

2. Unapproved share option schemes

Similar to CSOPs, they grant the employee the option to acquire a number of shares at a future date, at a specified price by the company, but they do not require HMRC approval. As a result they are often more flexible, quicker and simpler to set up, only selected employees need to be offered them and there are no hours worked or share capital restrictions here.

In terms of tax implications:

• Employee: there is no IT or NIC when they are granted, if exercised within 10 years of when option is granted. Upon exercise, there will be an IT liability (difference between market value of shares at that date less price paid for them). There is no NIC however, as long as the shares are not readily convertible to cash (i.e., no arrangements by which the shares’ value can be realised with certainty). On disposal the employees pays IT on the CG at 10%/20% (i.e., disposal proceeds less the price paid when the options were exercised).
• Employer: Company will receive a corporation tax deduction, on exercise, of the difference between the market value of the shares less the price paid by the employer for the shares.

The costs here are typically slightly lower than CSOPs.

3. Enterprise Management Incentives (‘EMI’)

EMIs are designed to help smaller companies (gross assets < £30million) with potential for growth, to recruit and retain high calibre employees and rewarding those employees for taking the risk of investing their time and skills to help the small company succeed.

They offer any number of employees the option to buy shares in the company at or less than the market value of the shares up to £250,000 each (or £3million overall) and they must be exercised within 10 years. Employees must work at least 25 hours a week (if less, for at least 75% of their working time), and not have more than 30% share capital.

Only selected employees need be included, voting restrictions can be placed over the shares (to protect the current owners) and they can be granted subject to performance criteria.

The company must notify HMRC within 92 days of the options being granted and the market value of the shares has to be agreed with the HMRC. Formal HMRC approval is not required, but it is possible to obtain advance clearance that the company (not the employees) will meet the requirements.

In terms of tax implications:

• Employee: there is no IT or NIC when they are granted. There is also no IT or NIC when exercised, unless the option was granted at less than market value, then there will be a tax charge on the difference (collected through PAYE). On disposal any CG may qualify for Entrepreneur’s Relief, reducing the rate of tax to 10%, regardless of the tax band.
• Employer: Company will receive a corporation tax deduction, on exercise, of the difference between the market value of the shares less the price paid by the employer for the shares.

In addition to our fees, the legal costs for setting these up are typically £2,000-2,500+VAT. They are however typically more common for small and medium-sized businesses as they can be cost effective and provide flexibility.

4. Share Incentive Plans (SIPs)

SIPs are designed to be flexible so all employees can participate and benefit from meeting specific performance targets. The shares acquired are held in a UK resident trust to ensure the independent legal ownership of the shares.

Each tax year:

• Employees can get up to £3,600 of “Free” shares free of IT and NI, some or all of which can be related to performance targets.
• Employees can then buy up to £1,800 of “Partnership” shares each tax year out of their pre-tax and NIC salary.
• Employers can then give employee “Matching” shares up to £3,600 free of IT and NI.
• Up to £1,800 of dividends can also be reinvested in shares tax-free.

Shares must leave the plan when the employees leave their job and the company can decide whether employees lose their free shares if they leave within 3 years of them being granted.

The offer to participate in SIPs must be available to all employees regardless of their role and work pattern, although a minimum period of employment can be specified of up to 18 months.

In terms of tax implications:

• Employee: if they keep the shares in a plan for 5 years there is no IT, NIC or CG on sale. If the employee take their shares out of the plan after three years, they will pay IT and NIC on the initial value of the shares (any increase while in the plan will be free of IT and NI). Employees who keep their shares in the plan until they are sold will have no CG to pay on sale. If they take the shares out and sell them later then there will be a charge (at 10/20%) on any increase in the value of the shares after they were taken out of the plan.
• Employer: Company will receive a corporation tax deduction, on exercise, of the difference between the market value of the shares less the price paid by the employer for the shares.

In addition to our fees, the legal costs of setting up these schemes start from around £2,000 plus VAT, as a Trust needs to be set up in addition to the setting up of the scheme, but again, they can quickly get significantly more expensive, depending who they are offered to and how complex the terms are. They are therefore more common for larger and limited companies.

Conclusion

Granting shares or share options can be a great way to motivate, stretch and retain key staff without paying cash directly to the employee or HMRC, and whilst maintaining control over your business, as they are typically only for very small shareholdings.

The scheme used however will depend on how flexible you want the scheme to be, when you want it to be available, the value/size of the business in question, the number of employees in question and how much the client is prepared to pay to set up the scheme. The most common scheme used by small and medium-sized businesses are EMIs, as they offer enough flexibility, whilst often being relatively cost effective to set up.

Contact us today

There are a lot of options here. If you want to talk through your specific circumstances and what is best for you and your team, our specialist team of business tax advisors are ready to help you, contact Black and White Accounting today, or call us on 0800 140 4644.