Equity incentivisation – what are your choices?
Read time: 4 mins
Service: Tax Sector: Payment services
There are a number of ways that you can provide equity stakes to employees. It’s tempting just to set up schemes that fit your commercial objectives, but have you thought about the tax implications? If you have a cross-border group, something which may provide a tax efficient solution in one jurisdiction is unlikely to do the same in another.
So what exactly can you do in the UK?
1. Unapproved share optionsThis is often the default position if an option holder doesn’t take wider advice. On exercise of the option, there is a tax charge based on the market value of the stock (at that time) less the strike price. This could either be to income tax or payroll tax, depending on the circumstances. If the exercise is on an exit event, this could mean the entire proceeds are treated as income.
2. Award of sharesWhere shares are gifted there will generally be a tax charge at the date of the gift, based on the market value. This is the case even if the shares were “promised” earlier, when they were of lower value. If the shares carry restrictions, the taxing point may be moved to a future date, but there could be reasons why that’s not recommended. Nil-paid or partly paid shares can be used to issue shares on payable deferred terms. This means the obligation to pay is left outstanding until a future date.
3. Enterprise management incentive (EMI)Here, options are granted under specific terms up to a maximum value of £250,000 per employee. At exercise, as long as the strike price paid is equal to the market value at the time of grant (which can be agreed in advance with HMRC), the growth can be taken free of income tax and National Insurance . EMI options must be in a company which is not more than 50% controlled by another. They can be granted in a non-UK parent company and there can also be more favourable capital gains tax available on the disposal.
4. Growth sharesIf your company already has significant inherent value and you only want an individual to benefit from future value, growth shares may offer a solution. This is a new class of shares which only gives right to value above a hurdle threshold, and may enable a capital only extraction after the award of a share with an initial low value. This can even be linked with EMI. However, care must be taken in structuring Growth share arrangements, so that they are commercially valid, and can’t be challenged as a tax avoidance scheme.
5. Company share option plan (CSOP)If EMI is not suitable, CSOP might be an alternative. Like EMI, there are a number of conditions but, if met, options up to the value of £30,000 can be awarded to an employee. The growth beyond the value at grant can be taken free of employment tax consequences, as long as the option exercises between three and 10 years after the grant.
6. Save As You Earn (SAYE)An all-employee plan where employees allow a proportion of their salaries to be saved monthly in an SAYE account. This can be between £5 and £500. It is accumulated over a three or five-year period with a tax-free bonus at the end. The savings account must be formally connected with a share option, offering the employee the chance to buy shares in the company at a discount of up to 20%. The savings provider should offer the equivalent of interest on the cash invested, but the rates fixed by the Treasury have been 0% for a number of years. The bonus rates are also at 0%, so many question the value of this scheme.
7. Share incentive plan (SIP)SIP is also an all-employee plan. Employers can offer four different types of share under a SIP: free shares (up to £3,600 per year); partnership shares (allocated from salary up to £1,800, or 10% of salary per year if lower); matching shares (to match partnership shares at a 2-for-1 rate); and dividend shares (reinvestment of dividends). There are different holding periods for each share type. But to benefit fully from the tax reliefs available under these plans, it’s usually necessary to hold the shares in trust for a full five years.
Beware the pitfallsThe above is only high-level advice. If you’re considering equity remuneration as part of your employment package, remember that approved share schemes carry many specific rules. Breaching them can mean the options are treated as unapproved. Future transactional events may cause a taxing point change from income tax to payroll tax. Restrictions on shares can lead to unforeseen future income tax events if you do not make the right choices.
All in all, we recommend you take detailed tax advice when any plan is implemented and as part of your wider incentivisation package planning.