According to the Nuttall Review of Employee Ownership, businesses with a significant proportion of their shares held by staff are more resilient in tough economic times and provide benefits to both employees and employers. Many companies choose to offer share incentives to their staff as a means of recruiting, retaining and motivating employees. Whilst this is typically done via some form of share option scheme, there are (excuse the pun) various different options to choose from and getting the right one will be key to engaging and motivating your team.
Approved company share option plan (CSOP)
This is a discretionary scheme so a company can choose which employees are granted an option to acquire shares under it. As the name suggests, the scheme must be approved by HMRC and there are strict conditions on the scheme’s rules. In particular, each employee cannot hold more than £30,000 of share options under a CSOP (based on the market value of the option shares when the option is granted) and the market value must be agreed with HMRC before grant.
Generally, a CSOP operates by giving an employee the ability to acquire shares at a later date (between three and ten years after the options are granted) at a price equal to the market value of the shares at the date of grant. Obviously the hope is that, in the intervening period, the shares will have increased in value so the employee will receive an immediate benefit when the option is exercised.
Provided the rules of the scheme meet the HMRC conditions, there should be no tax or national insurance contributions (NICs) either when the option is granted or when it is subsequently exercised. If, after exercising the option, the employee sells the shares, capital gains tax will be charged on the difference between the exercise price paid and the sale proceeds.
Unapproved share options
Unlike a CSOP, an unapproved share option does not require approval from HMRC. It is therefore more flexible – there are no conditions set by HMRC about the terms of such an option – but that increased flexibility comes with less favourable tax treatment compared to a CSOP.
Provided the option cannot be exercised more than ten years after the date of grant, there will be no tax or NICs on grant. When the option is exercised, income tax and possibly NICs will be charged on the difference between the exercise price and the market value at the date of exercise. On any subsequent disposal of the shares, capital gains tax will be charged on the difference between the market value of the shares at the date of exercise and the sale proceeds.
Unapproved share options can be used to ‘top up’ an employee’s incentive package once the £30,000 limit under a CSOP has been reached.
Enterprise Management Incentives (EMI)
EMI options are another form of discretionary scheme where the company can choose which employees participate. It’s also another scheme which receives favourable tax treatment from HMRC and therefore certain conditions must be met:
- To be eligible, an employee must work for the company for at least 25 hours a week or 75% of their working time
- The company cannot be controlled by another company, and it must have gross assets of less than £30m and fewer than 250 full-time employees
- The total value of EMI options granted to each employee cannot be more than £250,000 and the total value of all unexercised EMI options cannot be more than £3m
- The options must be exercised within ten years
- HMRC must be notified within 92 days of EMI options being granted
There will be no tax or NICs at the date of grant and, provided the option was granted at market value and is exercised within 10 years, there will also be no tax or NICs on exercise. Provided certain conditions are met, any gain on a subsequent sale of the option shares will qualify for entrepreneurs’ relief so capital gains tax is charged at 10%.
‘Save As You Earn’ (SAYE) or ‘Sharesave’ scheme
A SAYE scheme combines a savings plan with a share option (we recently launched our own SAYE scheme for Gateley employees). Employees are granted an option at a discount of up to 20% of market value. They also agree to save up to £500 a month in a savings plan in order to save up the exercise price. When the savings plan matures the employee can either exercise the option to acquire the (discounted) shares or simply elect to receive back their savings.
A SAYE scheme is not discretionary; it must be open to all UK resident employees and full-time directors. Although a SAYE scheme does not require prior approval from HMRC, companies which set up such a scheme must notify HMRC and confirm that the scheme meets the legislative requirements.
With a SAYE scheme, there will be no tax or NICs at the date of grant and, provided the option is exercised more than three years after it was granted, there will also be no tax or NICs on exercise. As with other schemes, capital gains tax will arise on a subsequent sale of the option shares on the difference between the exercise price paid and the sale proceeds.
Which is the right option for you?
When it comes to share options, there is no such thing as ‘one size fits all’. The right option for your company and employees will depend on a variety of factors, such as:
- Does the company satisfy the conditions for an HMRC approved scheme?
- Does the company want to choose which employees participate?
- Which scheme will give the best tax treatment for the participating employees?
- How many options does the company want to grant?
Careful consideration should be given to the driving factors behind the desire to grant the options, as well as the different available choices, to get the perfect fit.