One of the biggest challenges facing any business owner is not just attracting and retaining the best employees, but motivating them to produce their best work and drive the business forward. Salary and benefits may be a motivator, but combining an attractive salary package with an employee share scheme can prove to be a strong incentive for improving performance. 

An employee share scheme, also known as an employee share option scheme or employee share ownership scheme, does ‘what it says on the tin’ – it gives your employees a stake in the business that has the potential to directly reward their loyalty and effort.

Initial considerations

Employee share schemes are available in a number of different forms, which gives you the opportunity to develop a scheme that meets your specific goals and circumstances. For example, you may wish to motivate all your employees to meet strategic targets or you may wish to restrict the scheme to a limited number of key employees with skills or experience important to the business.

Alternatively, you might wish to offer shares to long-serving employees to reward loyalty, or offer shares as an alternative to bonuses or higher salaries. With this level of flexibility, you can offer a single scheme or a combination of schemes to meet different goals or motivate different groups of employees.

Whatever type of employee share ownership scheme you are considering, you need to consider the tax and National Insurance implications of different types of scheme, as well as your legal responsibilities. Some schemes are approved by HMRC and provide tax benefits while other, unapproved, schemes may not have tax benefits but may be a better fit for your business.

Planning a scheme

There are a number of factors to consider when planning an employee share scheme:

• Business goals – Why are you introducing the scheme and what do you aim to achieve – for example, retain key employees, meet strategic targets, attract new talent or reward performance?

• Employee eligibility – Which employees do you want to include in the scheme and what are the criteria for eligibility?

• Type of share scheme – Which scheme or combination of schemes will help you meet your goals?

• Scheme costs – Will you be offering employees free shares or will you be offering an option to buy? What are the likely scheme administrative costs?

• Share valuation – How will you set the initial value of the shares and determine any change in value?

• Administration and reporting – Who will administer the scheme and what are your legal and reporting responsibilities?

HMRC-approved share schemes

Approved share schemes are recognised by HMRC and offer important tax benefits.

Share Incentive Plans (SIP)

These schemes are aimed at businesses with more than 50 employees and must be available to all employees. You can offer each employee free shares up to a value of £3,600 per year.

The shares are held in an employee benefit trust, which can add significant costs to the scheme. Provided employees retain the shares for a minimum of 5 years, they will not have to pay any Income Tax or National Insurance contributions on the value of the shares. Eligibility is not dependent on any performance requirements and this, together with the personal tax benefits, makes the scheme useful for attracting and retaining employees.

Company Share Option Plans (CSOP)

This scheme is suitable for any size of business and you can offer participation to selected employees or your entire workforce. Generally, the scheme is used to incentivise or reward senior staff. Each participating employee can be given the option to buy up to £30,000 worth of shares at a fixed price and there is no limit to the total value of options that your company can offer.

Employees will not pay Income Tax or National Insurance contributions on the difference between what they pay for the shares and what they’re actually worth. However, if they sell the shares and make a profit, employees will be liable to Capital Gains Tax.

Savings-Related Share Option Schemes/Save as you Earn Schemes (SAYE)

This scheme is generally more suitable for larger businesses and there are a number of rules attached to the scheme. You must offer all employees the option to acquire shares at a value agreed with HMRC.

To acquire shares, employees save up to a maximum of £500 per month and can take up their options after a period of three, five or seven years, depending on your specific scheme rules. At the end of the period, employees can use their savings to acquire shares or withdraw the money with the additional benefit of a tax-free bonus.

Enterprise Management Incentive Schemes (EMI)

The Enterprise Management Incentive Schemes (EMI) schemes are aimed at smaller qualifying companies to help them attract and retain high-quality employees. If your company meets HMRC’s qualifications, you can offer options to selected employees as a tax-efficient supplement to their salary and benefits package.

Employees have the option to acquire shares in the future at a price agreed at the date of the offer. If the value of the shares is higher when the employees exercise their options, they can benefit by selling the shares and retaining the difference. You can offer each employee the option to acquire up to £250,000 worth of shares up to a limit of £3 million for all participants in the scheme. If participation in the scheme is linked to performance targets that increase the value of the shares, that can act as a valuable incentive.

Read More: Incentivise your management through an EMI scheme

Other employee share schemes

Although HMRC-approved schemes offer valuable tax benefits to employees, they are governed by rules that may make them unsuitable for your business. You can set up similar schemes that are unapproved and do not offer employees tax benefits. However, they may provide other benefits that are more important to your business. Unapproved schemes fall into the following broad categories:

Share Option Schemes

Similar to HMRC’s CSOP scheme, this scheme gives any employee the option to buy shares at an agreed period in the future, at a price fixed at the time of the offer. This scheme can be used as an incentive by tying the exercise date to achievement of a target. If share value has risen when the employee takes up their option, they can either retain the shares or sell them and make a profit that is subject to Capital Gains Tax.

Share Award Schemes

You can offer your employees free shares, usually for less than their market value. Unlike HMRC’s SIP scheme, the shares will be treated as an employee benefit subject to Income Tax and National Insurance contributions. Employees can sell the shares at their current market value, but any profit will be subject to Capital Gains Tax.

Share Purchase Schemes

Employees have the opportunity to purchase shares at any time at their current market value. They can also join a savings scheme to buy shares in the future. If employees sell their shares at a higher price, they will be subject to Capital Gains Tax on the profit.

Business benefits of employee share schemes

Setting up an employee share scheme offers employees valuable tax benefits, but it can also provide important benefits for your business.

• Encourages innovation and productivity improvements – Employees who own shares that may increase in value are incentivised to improve performance or focus on innovation.

• Reduces overall employee costs – Offering share options rather than salary increases or other benefits can reduce total remuneration costs and improve cash flow.

• Increases share capital – Offering employees the opportunity to purchase shares increases share capital for further investment in the business.

• Improves recruitment and retention – Share options can prove attractive to new recruits. They can also reduce employee turnover by offering rewards for long-term loyalty.

• Increases employee satisfaction – By offering employees a tax-efficient form of income, you can increase employee satisfaction.

Disadvantages of share schemes

However, there are also potential risks and disadvantages that may discourage some employees from participating:

• Share values – Like any form of investment, share values can go up or down. If values fall, employees face the risk of financial loss.

• Long-term commitment – With some schemes, such as employee share option schemes, employees may have to wait years before gaining any benefit. They may not be willing to risk missing future employment opportunities. If they leave before the required qualifying period, employees may have to repay any Income Tax or National Insurance relief provided by the scheme.

Support from Accounts & Legal

This is a brief outline of the scope, benefits and disadvantages of employee share schemes. If you would like professional advice on any aspect of the schemes, what to implement in your company, or would like confirmation that you are complying with HMRC’s rules, our team of in-house tax accountants and solicitors will be glad to help.

We’re uniquely placed to be able to do the math and the legal paperwork to make sure that you get it exactly right.

To find out more, please contact us on 0207 043 4000 or info@accountsandlegal.co.uk.