So far in our series on employee incentives, we have focussed on EMI options and some of the key considerations companies should make prior to entering into an EMI scheme. This week we look at some of the alternatives to EMI schemes and take a brief run through some of their advantages and disadvantages.
Recap on EMI scheme requirements
In the first blog in this series, we set out the conditions that a company must meet to be eligible for an EMI scheme. Some of the key requirements are:
- it must carry out a qualifying trade (broadly speaking this is any trade, except banking, insurance and property companies);
- the gross assets of the company do not exceed £30 million;
- it must have fewer than 250 full-time employees; and
- it must be independent and not be under the control of any other company (“Independent Company).
Alternatives to EMI Options
As alternatives, there are both tax-advantaged and non-taxed advantaged arrangements that a company can consider. In this blog we will look at three of the main tax-advantages schemes:
- Company share option plans (CSOPs);
- Save as you earn (SAYE); and
- Share Incentive Plan.
We will also briefly consider unapproved schemes as it is helpful to outline tax position by comparison of a non-tax advantaged scheme.
Company share option plans (CSOPs)
The CSOPs are similar to EMI schemes, but can be used by larger companies that are excluded from the EMI schemes due to their size. The company must either be listed on a stock exchange, or be an Independent Company. The advantages to the CSOPs are that:
- the increase in the value of the shares between the grant and the exercise of the options should be free of income tax and NICs (providing they are not exercised early, i.e. within three years of the date of grant)
- it does not have to be offered to all employees -the company can choose who to provide them to;
- conditions can be imposed on the exercise of the option; and
- there is no financial commitment required from the employees until the exercise of the option
The disadvantages of the CSOPs are that:
- there is a cap of £30,000 of shares that may be held by an individual in unexercised CSOP options, which may not be appropriate for a high growth company;
- options cannot be granted with an exercise price less than market value at grant; and
- apart from certain exceptions, options must not be exercised within three years of the date of grant for the tax advantages to apply.
SAYE Option Scheme
The SAYE scheme has two elements: a savings arrangement and a share option. The employee will need to enter into a HMRC-certified savings arrangement, which will require a payment to be made every month for three to five years. At the end of the term, the employee can use the proceeds to fund the exercise price of the option. Companies that set up SAYE schemes must be either be listed on a recognised stock exchange or be an Independent Company and are typically larger companies and groups. The SAYE schemes are all-employee schemes, meaning all eligible UK-resident employees and full-time directors must be invited to participate, although a qualifying period of service can be imposed. The advantages to the SAYE scheme are:
- they reward only those employees who make a financial commitment into the savings scheme;
- risk-free investment for the employees, because if the share price goes down during the savings contract employees still receive their savings and possibly a tax-free bonus;
- provided the scheme meet the legislative requirements, there won’t be any PAYE or NIC to make; and
- option exercise price can be up to 20% less than market value.
The disadvantages to the SAYE scheme are:
- it has to be offered to (almost) all employees so is less flexible;
- there is a limit of £6,000 annual savings;
- complex administration;
- savings have to be made from after-tax pay; and
- some accounting issues may arise with the SAYE schemes.
Share Incentive Plan (SIP)
SIPs are plans that provide all employees with the opportunity to acquire shares. These plans need to be pre-approved by HMRC The can be four distinct parts to SIPs: Free shares; Partnership shares; Matching shares; and Dividend shares. A company can decided to offer either the Free Shares or Partnership shares, or both. Matching shares and Dividend shares are not covered further in this note. The advantages to SIPs are:
- they are flexible – the company can decide which elements it wants to implement in each tax year;
- an employee can buy a maximum of £1,800 shares per year;
- the Company can give free shares to employees (currently limited to £3,600 per annum, plus £3,600 of Matching shares and they can be awarded subject to performance targets;
- shares can be subject to restrictions, including forfeiture (i.e. good leaver/bad leaver);
- any money deducted from salary to buy partnership shares is free from income tax and national insurance contributions, but this can affect benefits entitlements of low paid participants;
- SIP shares are exempt from capital gains tax as long as the shares remain in the SIP trust; and
- plans may allow reinvestment of dividends into plan shares tax free (subject to certain limits).
The disadvantages to SIPs are:
- they can be complex to set up, with high administration costs and ongoing HMRC registration requirements;
- the plan shares needs to be offered to (almost) all employees;
- employees become the beneficial owners of the shares, rather than option holders; and
- the tax rules are complicated and tax reliefs can be clawed back in certain circumstances.
Unapproved Share Options
This is an option which does not have tax favoured status of an EMI scheme or some of the schemes considered above. The advantages of an Unapproved Option Scheme are:
- it is simple to set up and administer;
- it allows a company to grant additional options to an individual who may have exceeded limits under other schemes;
- flexibility; and
- there is no income tax charge on the grant of the option.
The disadvantages are:
- income tax at rate of 40% for higher rate tax payer will be charged on the difference between market value of the shares at the date of exercise vs the exercise price;
- there can be withholding obligations for the company in respect of PAYE if the shares are readily convertible assets’ – this would apply to listed shares or shares in a company being sold and certain other circumstances;
- NIC obligations for both company and option holder in certain circumstance. This could mean a further 14% NIC charge in addition to the 40% income tax charge for a higher rate earner;
- CGT for UK residents on the difference between market value on date of exercise and the price per share received on a sale. This rate would be 18% of the gain, moving up to 28% for higher rate earners.
For most smaller growth companies the above schemes will not be as appealing as EMI schemes that we have considered so far in this series. If an EMI scheme is not viable, careful consideration is needed at the outset as to what alternatives would work for your company and employees. Whilst certain plans offer some favourable tax treatments, this should be weighed against the administration requirements and costs of running those schemes. If you are considering equity incentives or have any questions on this article, feel free to get in touch with an expert by contacting Angus Bauer, Partner at Ashfords LLP on firstname.lastname@example.org. Our final blog, next week will cover what to look out for on an exit of an EMI scheme.
Article produced in partnership with Angus Bauer and Rory Suggett at Ashfords.