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Employee Share Schemes (ESSs) can be a powerful tool for incentivising your workforce by allowing them to have a stake in your business’s success. By offering shares or share options, you can align your employees’ interests with those of the company and its shareholders. Employees who own shares are motivated to increase profitability and long-term growth, directly benefiting them. This article will outline the key advantages and disadvantages of different ESSs.
Overall Benefits
ESSs allow employees to acquire shares in the company they are employed by, either at a discounted price or under advantageous terms. The UK has several employee share schemes approved by HM Revenue & Customs (HMRC), which allow employees to buy shares in their company at a pre-agreed value without triggering the need to pay income tax, or using their pre-tax salary or by saving a regular amount over a fixed period to purchase shares at a discounted price.
Firstly, ESSs help attract and retain top talent by providing additional compensation beyond salaries. This can make your overall remuneration package more competitive, especially for businesses that may not be able to match larger competitors’ wage levels. Additionally, ESSs foster a sense of ownership and commitment among employees. Those who hold shares develop a vested interest in the company’s sustainability, often leading to increased productivity and loyalty.
ESSs can be particularly useful during periods of limited cash flow. Instead of increasing salaries, you can offer tax-efficient, share-based incentives, potentially deferring tax liabilities for your business and employees.
The UK has several HMRC-approved employee share schemes, each with rules and regulations. These options are outlined below.
Enterprise Management Incentives (EMI)
The EMI scheme is tailored for smaller businesses with:
- under 250 full-time employees; and
- assets below £30 million.
With a relatively straightforward setup process, you can grant options worth up to £250,000 to any of your qualifying employees during a three-year period and up to a maximum of £3 million worth of options in total. The selective approach and favourable tax treatment make EMI appealing to higher-earning employees in higher tax brackets.
When exercising options, provided that the employees pay an exercise price that is at least equal to the HMRC-approved market value of the shares at the time the option was granted, your employees do not have to pay income tax and national insurance contributions (NICs). Instead, they must only pay capital gains tax upon selling shares, potentially at just 10% on the first £1 million of gains.
In order to qualify for an EMI scheme, your employees must:
- work at least 25 hours per week; or
- dedicate 75% of their paid time.
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Company Share Option Plans (CSOP)
You can use a CSOP to grant employees the right to purchase shares in the future for a pre-set price. This price must be at least the market value of the shares at the time the option was granted. Changes from April 2023 doubled the individual limit to £60,000, with no overall company or three-year limit on the number of CSOP options that can be issued.
CSOP serves as an alternative for companies who have outgrown the EMI scheme. For example, this may apply if you have more than 250,000 employees. Additionally, with a few exceptions, no income tax or NICs are due when employees exercise CSOP options. However, CSOPs are more limited than EMI options as, subject to a few exceptions, the options can only be exercised between three and ten years after being granted in order to benefit from the tax relief. Capital gains tax also applies when the resulting shares are sold.
Share Incentive Plans (SIP)
Through a SIP, you can distribute shares to employees in four ways:
- Free Shares: You can give up to £3,600 worth of free shares per employee per tax year.
- Partnership Shares: Employees buy shares from their gross salary up to the lower of £1,800 or 10% of their annual income.
- Matching Shares: You provide up to two free matching shares for each partnership share an employee buys.
- Dividend Shares: Employees can use dividends from existing shares to buy additional dividend shares. If held for at least three years, no income tax is due.
Employees pay no income tax or NICs as long as they retain SIP shares for at least five years. There are also some exceptions to paying capital gains tax if the employee keeps the shares in the plan until selling or transferring them to a savings account or pension scheme.
SIPs have to be open to all eligible employees and cannot be used selectively.
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Save As You Earn (SAYE)
SAYE allows you to offer three or five-year contractual savings agreements. Employees can save up to £500 monthly and can choose whether to:
- receive their cash back at the end of the period; or
- use the accrued savings to purchase company shares at a pre-defined, discounted price (up to 20% discount).
There is no income tax or NICs due to the difference between what the employee pays for the shares and their market value at the time they are purchased. The SAYE scheme has to be open to all eligible employees and cannot be used selectively.
Disadvantages of ESSs
While ESSs offer compelling benefits, there are potential disadvantages to consider:
- Dilution of ownership: Issuing shares to employees dilutes your ownership and control. Retaining at least 75% voting shares allows you to maintain authority over critical decisions.
- Administrative burden: Setting up and managing ESSs can be complex and time-consuming, often requiring professional advice.
- Cost implications: Implementing ESSs incurs additional expenses, including legal fees, valuation costs, and potential tax liabilities.
- Potential for disputes: Disagreements over share valuations or scheme terms can strain relationships and lead to legal issues.
- Risk of underperformance: If your company’s performance or share price disappoints, employees may become demotivated, which can impact retention and culture.
Key Takeaways
Proper structuring with legal guidance is crucial to maximise the motivational advantages of ESSs while protecting your leadership position. ESSs carry many benefits, including retaining top talent by providing additional compensation and ensuring employee loyalty. With expert assistance, you can capitalise on the benefits while mitigating the risks, fostering a motivated and committed workforce.
If you require more information on employee share schemes, our experienced employment lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. So call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Typically, if the employee exercises the options within 90 days of leaving and has an acceptable reason for leaving, such as retirement or a disability, they will retain their tax benefits. However, if this does not apply, they may face tax liabilities such as national insurance contributions.
Firstly, you should ensure that your employees are eligible for the scheme. It is important to use clear documentation and seek professional advice to ensure that you abide by relevant laws and regulations.
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