Tax Talk: So you have a share scheme – what next?

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Setting up a share scheme can be an excellent idea for a young business. But what do you do once you have one? Shona Barker discusses the next steps.

If you’re a growing business looking to hang onto employees who are helping you become the next big thing, it’s likely that you already have, or have considered, a share incentive scheme of some form. The most common type is an Enterprise Management Incentive (EMI) scheme. An EMI is a tax-efficient share option scheme with generous eligibility thresholds that allow you to give your best employees the chance to buy shares later, rather than giving away equity now. But once the share scheme is all set up – what do you do with it?

Annual reporting

If you have a share scheme of any kind, you will have to do annual reporting by 6 July following the end of the tax year. It’s a commonly overlooked requirement, but can result in significant penalties if you miss the deadline. If someone helped you set up the share scheme, they are probably on standby to help you with the annual filing requirements. But don’t assume!

Giving away more options

If you have an EMI, you must tell HMRC about any new grant of options within 92 days, or your employees won’t get the tax breaks you’ve promised them. So make sure you notify HMRC promptly or, if you have an advisor, communicate with them. Don’t leave it to the end of the year to casually mention you granted loads of options six months ago.

Thankfully, the in-year notification requirement does not reply to other types of options.

Levelling up

If you have a Company Share Option Plan (CSOP) in place, this won’t stop you from also setting up an EMI. CSOPs are pretty restrictive, so you might later choose to set up an EMI if the size limits allow.

It’s important not to double count. For example, you can give an employee share options with a Market Value of up to £250,000 under an EMI. But if the employee already has options of £30,000 under a CSOP, this maximum is reduced to £220,000.

Remember, you can go over the thresholds. But awards over that threshold will be unapproved share options that don’t have the same excellent tax perks.

What to do about new employees?

New people are often the trickiest consideration from a commercial perspective. If they didn’t get in on day one, what is the fairest way of treating them?

  1. Share options in the existing plan

Ultimately, this will dilute equity for the existing people hoping to acquire shares in the future. But EMI option holders may not care, as the usual 5% minimum shareholding for Business Asset Disposal Relief (BADR) does not apply to shares acquired under an EMI. BADR is the special relief that reduces Capital Gains Tax (CGT) to only 10%. Other option holders may have a different view, though they might have been less likely to qualify for BADR in the first place.

You have no choice but to offer CSOP options at Market Value. But if you gave your longest standing employees EMIs at a hefty discount – or even at an exercise price of £nil – you could consider offering the new people a lower discount.

  1. Growth shares

If your company is expanding, and an EMI is no longer available to you, you could consider bringing growth shares into the mix for new senior executives. Growth shares are a bespoke class of ordinary shares that only benefit from value growth over a defined threshold that is higher than the current company value. So they’re lower in value than ‘normal’ ordinary shares, as they don’t benefit from the current inherent value.

But growth shares carry an increased risk for the employee. That’s because they have some value and the employee must purchase them up front (or pay tax on any discount received). And there’s no guarantee they’ll rise in value so they may never provide a return.

You can design highly customised terms (‘hurdles’) that the executive must hit to benefit from the shares. Although the new person will have equity straight away, they’ll have to properly commit to the business to get anything out of it. And this can help maintain a sense of fairness for employees who have been around since the start.

  1. Unapproved share options

Although growth shares can be beneficial, they are complex to adopt. Particularly for more junior employees, the cost and complexity up front may outweigh potential benefits.

Although little beats an EMI, unapproved share options will still let you bring people into the business at a future date or, more likely, allow them to participate on an exit.

But employees exercising unapproved options will be taxed on all the growth as employment income and pay Income Tax – and probably National Insurance, too, if they are only exercised when the business is sold. It may not be tax-efficient, but given a choice between unapproved share options and nothing, hardly anyone would plump for nothing.

With unapproved share options, as you’re not receiving any taxation benefits, at least you can write pretty much any term you like. There’s a lot of flexibility.

  1. Bonus

If you can’t get the maths to work, you could consider an old-fashioned cash bonus. Equity, or the promise of equity, can significantly increase employee retention. But there’s nothing to stop you providing bonuses against measurable targets that grow the value of the business – or on the occurrence of a specific event (for example, a sale).

Remember, one of the key taxation benefits is access to lower CGT rates (compared to income tax) on a share disposal, compared to a bonus. But as you’ll have seen in the press, there are continued suggestions that the rate of CGT may increase. And, if so, the gap in tax efficiency between cash and share plans would reduce.

What’s best for my business?

Now, that’s the killer question. The honest answer is: it depends. So if you’re trying to decide how best to remunerate your key employees, consider what matters to your business, your incoming employees and your existing employees, and speak to Shona Barker or your usual PKF Littlejohn contact.