42 Degrees - Business from a different angle

Geoffrey Bond, a senior partner at the RM2 Partnership, a leading specialist in employee share schemes, answers the most commonly asked questions.

Q. What are the mechanisms by which employees acquire shares?
A. Employees can acquire shares in three principal ways:

1. Gift of shares
   Increasingly, gifted company shares are offered to employees as a core benefit, alongside pensions or health insurance. If the shares are placed in trust under an approved Share Incentive Plan, any gain in value is free of tax after three years, the whole value is tax-free after five years.
   
   Alternatively, restricted shares can be offered. The restrictions will reduce the initial taxable value, but income tax will be payable sooner or later on the unrestricted part of the value and on the equivalent portion of any subsequent gains.
2. Share options
   A share option is the right (but not the obligation) to buy shares in the future for a consideration agreed today. The value of the share option increases if the value of the shares increases.
   
   The employee benefits from the increase without initially paying for the shares. If a government scheme can be used, the tax treatment may be very favourable. However even an unapproved option is subject to tax only when exercised.
   
   The available government schemes are the Enterprise Management Incentive and the Company Share Option Plan.
3. Share purchase
   If employees purchase shares at full value, later gains will be taxed at potentially just ten per cent or less. Employees can save to acquire shares on favourable terms through an approved Savings Related Share Option scheme.
   
   Employees can also be offered partly paid shares through a deferred purchase plan. They initially pay just a fraction of full value, but will then pay a small annual tax charge until the full value is paid up.

Q. What are the main types of scheme?
A.  There are two major types. Approved or Registered plans carry significant tax benefits. Everyone is, of course, free to arrange their own unapproved schemes, but they may lose tax breaks.
Registered and Approved schemes are as follows:

1. The Enterprise Management Incentive
   A flexible and tax efficient share option plan, that allows you to target selected individuals with up to £100,000 worth of shares. It’s available only to smaller companies. Certain types of trading activity are excluded.
2. The Share Incentive Plan
   Employees receive allocations of shares that are held for them in trust, up to a value of £3,000 pa. Employees can also purchase a further £1,500 worth of shares, and if they do, employers may provide up to £3,000 worth of additional free shares. The tax treatment is favourable. If all three methods are used, each employee may therefore acquire each tax year shares to total value of £7,500, comprising free shares worth £3,000, Partnership Shares worth £1,500 and additional matching shares worth £3,000.
3. The Savings Related Share Option Scheme
   Employees save over three, five or seven years to acquire shares in the company at a price fixed at the outset. The savings attract tax-free bonuses and there is favourable tax treatment of the profits on sale of shares acquired. Approved SAYE (Save As You Earn) Share Option Schemes are a highly tax efficient method for both quoted and unquoted companies to transfer value to employees. Through the SAYE contract employees agree to save a given sum of money each month with a bank or building society (up to £250 per month).
4. Employee Benefit Trusts
   Selected employees may receive options to acquire company shares. One of the benefits of this scheme is that employers can link the share option and its exercise to specified performance conditions. Taxation of gains is on favourable terms, subject to Government regulations. Options can be awarded over the shares of UK private, public or listed companies and also over the shares of foreign parent companies. Each employee can be granted options to buy company shares worth up to a total of £30,000 at the date of grant.
5. The Company Share Option Plan
   Trusts are an important feature of many approved and unapproved schemes. They provide separate legal ownership for employee benefits and also facilitate "internal markets" in the shares of unquoted companies. A properly constituted Employee Benefit Trust is able to purchase and hold shares for the benefit of employees, providing a flexible and efficient internal market for the shares. EBTs are often used as the grantor of share options or other equity benefits for employees of unlisted companies.

Q. How do I choose the right share scheme?
A. Follow these steps and seek good professional advice.

1. What are my objectives?
   These will typically include one or more of the following:
    – attracting and retaining staff across the whole firm
    – fostering a culture of team work and commitment
    – providing targeted incentives to selected staff
    – conserving cash and reducing the cost of performance based bonuses
    – establishing a succession plan or exit strategy
   
2. Match the scheme to the objectives
   Are you looking to enhance the working culture across the entire workforce? If so you may consider an all employee plan such as a Share Incentive Plan – this can combine elements of share gift and share purchase by employees. Alternatively, you could consider an all employee savings related scheme or an all employee share option scheme.
   
   Are you focusing on a core group of key individuals? In this case you may want to use a discretionary scheme such as the Enterprise Management Incentive or Company Share Option Plan. Your company may not qualify for one or both of these in which case you could consider a deferred share purchase plan or an unapproved share option scheme.
3. Should I use a tax-efficient approved scheme?
   Government approved schemes can deliver large tax savings to both employer and employees – but are subject to restrictions. To assess the benefits vs. the restrictions, take advice on the particular scheme you are considering.

For more information about employee share ownership, contact:
RM2 Consultancy
Business link
The Employee Share Ownership Centre