Employee Share Incentives
Employee Share Incentives Employee share schemes are used to reward employees in a tax effective way. They can be targeted at a particular group or offered to all employees so that a company can attract and retain the best staff and encourage employees to identify with the company s goals. Legislation to prevent employees being paid bonuses and other benefits in ways that avoid income tax and NICs has largely restricted planning opportunities to Revenue approved share schemes. There is a complex code of legislation relating to employee share ownership which can affect transactions that are not entered into for tax planning reasons. It is therefore important that you seek advice before granting options or giving shares to your employees and directors, or altering the rights attaching to shares that they have already received. 2 Employee Share Incentives
Incentives Employees can be rewarded by shares, cash bonuses or options. Phantom share schemes, which are effectively cash bonuses, are simple to administer and can be linked to specific targets for particular employees, but are not tax efficient. Tax efficient share schemes are largely limited to all employee schemes, though awards can be linked to specific targets to some extent. Their chief drawback is equity dilution and creating minority shareholdings. Share option schemes postpone the problem of equity dilution, and tend to be focused on rewarding management rather than employees. Listed below are some of the different ways to give an interest in the value of a company. Acquisition of Shares Phantom Share Scheme Ordinary Share Option Company Share Option Plan (CSOP) Enterprise Management Incentives Scheme (EMI) SI SAYE Sharesave Share Incentive Plan (SIP) Employee Share Ownership Plan (ESOP) Employee Shareholder Shares Employee - Ownership Trust 3 Employee Share Incentives
Acquisition of Shares The simplest method of rewarding an employee would be to give them shares in the company but it is not tax efficient. Either the employee has to pay market value for the shares at the time of acquisition or he will be taxed on the benefit conferred, and he may have difficulty paying for this without selling the shares. Simple and cost effective Starts the 12 month clock for CGT Entrepreneurs Relief If employee pays market value then no income tax/nic CT deduction if employee does not pay market value for shares (in some cases) If employee does not pay market value, then there will be income tax on the benefit Tax collected through PAYE/ additional NIC charge where readily convertible assets Generally either have to pay to purchase the shares or pay the tax due - may have to sell shares Minority interests: - Dilutes ownership - Share in dividends - May be difficult to sell There is a tension between funding the amount payable for shares and the potential income tax and NI consequences. The latter are minimised if the shares are acquired at market value but this maximises the consideration which has to be given at the outset. One possible solution is to issue the shares nil or paid part. If the shares are issued nil paid, no consideration is paid until called by the company; for example, on the sale of the company. Generally, the amount of the consideration left outstanding is treated as a notional interest free loan which can give rise to a taxable benefit in kind. However, this does not apply if, broadly, the shares are in a trading company, it is controlled by five or fewer shareholders and the individual is a full time director. It should be noted that an income tax liability will arise on an amount equal to the loan if the shares are sold before the capital is paid up and, in the unfortunate event that the company is wound up, a liquidator would call for payment of the outstanding amount. 4 Employee Share Incentives
Phantom Share Scheme An employee is given a cash bonus based on the value of a specified holding of shares (whether under a formal agreement or otherwise) when the company is sold/ floated but does not actually hold any shares/ options. No dilution of company ownership Payment is tax deductible in Company Employee has contractual right if scheme set out in writing Taxable on individual at 20% / 40% / 45% National Insurance payable by both company and employee Can also affect price of company on disposal due to requirement to pay the bonus Share Options Individuals Options can be granted to an employee either: A) outside an HM Revenue & Customs (HMRC) approved option scheme where no set conditions apply resulting in greater flexibility; or B) under either of two HMRC approved option schemes where certain conditions apply i.e. options over shares worth a maximum of 30,000/ 250,000 at market value can be granted. SI 5 Employee Share Incentives
Ordinary Share Option Non-approved Scheme Minimal, if any, initial payment by employee on grant of option No tax on grant of option, whether at market value or not CGT due on any gain made between exercise of option and sale. (Annual Exemption and Entrepreneurs Relief may be available) Complete flexibility on what conditions or terms to include in agreement CT relief if strike price is less than market value of option at exercise, subject to conditions being met No time limit during which option must be exercised What is a minority interest in an unquoted company worth (except on a sale/ float)? Income tax due on gain made at time of exercise of option (on difference between price paid and market value at date of exercise), accounted for under PAYE if shares are readily convertible assets Possible National Insurance on exercise of option if shares are readily convertible assets CGT Entrepreneurs Relief clock will start to run only from date option exercised Eventual possible problems with minority interests when paying dividends or when selling/ floating company (employee will partake in dividends if option exercised) Eventual dilution of ownership Possible charge on variation, loss or release of an option if consideration is received 6 Employee Share Incentives
Company Share Option Plan (CSOP) HM Revenue & Customs Approved Minimal, if any, initial payment by employee on grant of option No National Insurance on grant of an option No tax on grant of option No tax on exercise of option, if more than 3 years (or less if a good leaver ) and less than 10 years from date of grant Any gain over price paid for shares on eventual sale would be treated as a Capital Gain (Annual Exemption and Entrepreneurs Relief may be available) Limited to 30,000 market value of shares at time of grant per employee. Must be granted for market value payable on exercise of options Generally, must wait a minimum of 3 years to obtain tax reliefs CGT Entrepreneurs Relief clock will start to run only from date option exercised Eventual possible problems with minority interests when paying dividends or when selling/ floating company (employee will partake in dividends if option exercised) What is a minority interest in an unquoted company worth (except on a sale/ float) Performance, timing and other criteria SI can be applied to restrict timing of vesting / exercise of option CT relief on difference between price paid by the employee and market value at exercise, subject to conditions 7 Employee Share Incentives Eventual dilution of ownership Limited to full time directors (who must work at least 25 hours per week) or any non-director employee
Enterprise Management Incentives Scheme (EMI) HM Revenue & Customs Approved No tax or NIC on grant of option No Income Tax or NIC on exercise of option if exercise price is no less than market value on date of grant Limited to 3 million worth of options at any one time per company Limited to 250,000 market value of options at time of grant per employee (also must not own more than 30% of company) Any gain over price paid for shares on eventual sale would be treated as a Capital Gain (Annual Exemption may be available) Employee must work for at least 25 hours per week for the company (or 75% of working time, if less) For disposals after 5 April 2013, Entrepreneurs Relief is generally available provided the option was granted at least a year prior to the disposal; it is not necessary to hold 5% of the voting share capital Performance, timing and other criteria can be applied to restrict timing of vesting/ exercise of option Company must not have gross assets of 30m or more nor be a subsidiary of another company. Must also carry on a qualifying trade and have less than 250 employees What is a minority interest in an unquoted company worth (except on a sale/ float)? CT relief on difference between price paid by the employee and market value at exercise, subject to conditions Eventual dilution of ownership for existing shareholders. Options must be exercised within 10 years of grant to benefit from tax relief 8 Employee Share Incentives
Share Options - All Employee Schemes SAYE Sharesave - HM Revenue & Customs Approved Can acquire shares at discount of up to 20% of market value at date option granted and not pay income tax Save up to 500 per month for either 3 or 5 years and receive a tax free bonus.* These savings can then be used to fund cost of acquiring shares Can encash savings (free of tax) if don t want to take up options SAYE shares can be transferred, within 90 days of acquisition, into an ISA (subject to normal subscription limits) and subsequently sold tax free Must pay for shares CGT Entrepreneurs Relief clock will start to run only from date option exercised Eventual possible problems with minority interests when paying dividends or when selling/ floating company (employee will partake in dividends if exercises option) What is a minority interest in an unquoted company worth (except on a sale/ float)? *The rate of bonus varies dependent upon general interest rates and has been nil since August 2012. SI 9 Employee Share Incentives
Share Ownership Share Incentive Plans ( SIPs ) - HM Revenue & Customs Approved Up to 3,600 of free shares per year can be given to each employee Employees can also purchase up to 1,800 (from pre tax/ NIC money) worth of partnership shares Up to 3,600 of free matching shares if employee purchases partnership shares No income tax on dividends reinvested in SIP shares Must hold shares for 5 years to obtain tax free benefits Partnership shares cannot be forfeited on leaving employment If partnership shares withdrawn from scheme within 3 years, taxed on market value at that time; if within 5 years, on original value (or market value if lower) Reinvested shares cannot be forfeited on leaving employment No up front Income Tax or NIC If shares retained in the plan, no income tax or NIC when shares sold; otherwise CGT on increase in value after shares taken out of SIP If free or matching shares held for 3 years, only subject to income tax/ NIC on initial value of shares, not on any subsequent uplift Shares acquired under a SIP can be transferred, within 90 days of acquisition, Shares into an acquired ISA (up to under normal a SIP subscription can be transferred, limits) and within then 90 subsequently days of acquisition, sold tax into an free. ISA (up to normal subscription limits) and then subsequently sold tax free. 10 Employee Share Incentives
Employee Share Ownership Plan (ESOP) Non-approved scheme This is a Discretionary Trust which can act as a warehouse for shares in company Can acquire shares either from other shareholders or by subscription from company; potential capital gains and inheritance tax reliefs available to tranferor. Thereafter shares made available to employees directly or via share options Employees not taxed until shares allocated or distributed to them Complete flexibility on who receives benefit Trust can be used to provide other benefits rather than just shares May need to use an Offshore Trust to avoid possible double tax charge, once on sale of shares in Trust and then on individuals when distributed, although certain reliefs are available to mitigate the double charge Income tax and National Insurance payable (subject to employee NI limit) on allocation No deduction for employer payments to trust until shares allocated to specific employees Taxable on individual at 20% / 40% / 45% Immediate dilution of ownership Can be used to create a market place for shares, which may otherwise SI be hard to sell. This can be seen as giving additional value to share awards 11 Employee Share Incentives
Employee Shareholder Shares The term Employee Shareholder refers to the status of an individual for the purposes of employment law. If the individual and their employing company agree that the status will apply, the individual: i. is given Employee Shareholder shares with a market value of at least 2,000 in the employing company or its holding company, and ii. forgoes certain employment rights No income tax or NI liability arises on the first 2,000 of the value of the Employee Shareholder Shares. In addition, gains on Employee Shareholder Shares with a market value of up to 50,000 at the date of acquisition are exempt from CGT on a subsequent sale. Employee - Ownership Trust (EOT) An EOT provides indirect ownership through a trust: employees are benficiaries of a discretionary trust which owns shares in their employing company. The best known example is the John Lewis Partnership. To qualify as an EOT for tax purposes: the company must be a trading company or the parent company of a trading group the trust must operate for the benefit of all employees, other than certain excluded participators the trust must have a a controlling interest in the company SI 12 Employee Share Incentives Where an individual transfers shares to a qualifying EOT in the year in which the EOT acquires a controlling interest in the company concerned, no capital gain arses (regardless of the actual consideration) on the shares transferred. Relief from potential inheritance tax consequences is also available. Provided that all employees participate on equal terms, bonus payments of up to 3,600 per employee in a tax year are exempt from income tax.
How we can help We have extensive experience in helping our clients to successfully implement tax efficient employee share incentives. We will work with you to develop the right solution for your company, draft the necessary paperwork and make the required filings with HMRC. About the firm HW Fisher & Company is a commercially astute organisation with a personal, partnerled service aimed at entrepreneurial small and medium-sized enterprises, large corporates and high-net worth individuals. Our tax team includes seven partners, five tax principals and more than 40 staff specialising in both corporate and personal tax. Our corporate tax services include tax planning, corporation tax advice, share valuations, and advising on corporate transactions including mergers and acquisitions. The tax partners and staff are practical, hands-on practitioners, and are experienced in negotiations with HMRC at the highest level. We also provide personal tax advice for a great many clients on a wide range of issues including capital gains tax planning, inheritance tax planning and flexible remuneration schemes. The wider firm is a multi-faceted group with specialist companies active in corporate finance, financial services, property, and mergers and acquisitions. For more information, please contact: SI Brian Lindsey T 020 7380 4995 E blindsey@hwfisher.co.uk www.hwfisher.co.uk 13 Employee Share Incentives Toby Ryland T 020 7874 7959 E tryland@hwfisher.co.uk Andrew Jones T 020 7874 7823 E akjones@hwfisher.co.uk
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