Many new businesses, particularly early-stage technology startups where specific skills are needed but funding might be tight, offer employees shares in the business in lieu of a larger salary.
If you need practical, cost effective advice on the tax implications, commercial, financial or other advantages or disadvantages of gifting shares or setting up schemes, options for employee shares or how any of these options may alter how your business is valued later, talk to us. We can help.
Having a stake in the company may also improve an employee’s level of productivity, give them a sense of responsibility and ownership and strengthen their commitment to the business, since their shareholding is an asset that could increase in value with the right effort, commitment and hard work.
Obviously equity in a startup carries rather more risks, and is much less liquid, than cold, hard cash, but many employees are willing to accept the risk in hopes of owning a valuable stake in a future Facebook, Virgin or Innocent Drinks.
But how should a small business owner go about giving employees shares in the business? What share schemes are available and do they offer any tax breaks?
Let’s take a look.
In September 2013 the British government introduced a new employment status, through which an employee can receive up to £50,000 worth of shares in a company they work for with no future liability for Capital Gains Tax (assuming a gain is made when the shares are sold, of course).
In exchange, this ‘employee shareholder’ has to give up several statutory employment rights, such as unfair dismissal rights, rights to statutory redundancy pay and the right to request a flexible working arrangement.
Prior to March 2016 there was no cap on the size of the tax-free capital gain available to employee shareholders, but during Budget 2016 George Osborne revealed his plan to introduce a £100,000 lifetime limit on this tax break.
The government guidance on Employee Shareholder Status outlines a compulsory series of steps that must be taken before an individual can accept an employee shareholder offer:
If the individual accepts the job offer then the shares he or she receives must be worth at least £2,000 (but no more than £50,000), and the shares must be fully paid-up.
The employee isn’t allowed to pay anything for the shares.
Introduced in 2000, Share Incentive Plans enable employers to incentivise staff by offering them shares on an ongoing basis, rather than in a lump sum.
SIPs can offer employees shares in four ways:
Free shares – companies can offer employees up to £3,600 of free shares each tax year.
Partnership shares – employees can choose to buy shares in the company through their salary before income tax and national insurance are deducted, resulting in a tax break on the purchase. Employees can spend either £1,800 a year or 10% of their income (whichever is lower) to buy partnership shares.
Matching shares – if an employee does choose to buy partnership shares in a given tax year the employer can then ‘match’ those shares with two free shares for each partnership share that’s bought.
Dividend shares – finally, if an employee receives a dividend from shares he or she already owns this dividend can be used to buy more shares in the same company.
Provided shares acquired through a Share Incentive Plan are held in the plan for at least five years they will be exempt from Income Tax and National Insurance, and if they are held in the plan until they are sold then the shares will also be exempt from Capital Gains Tax.
Save As You Earn is a company share scheme that enables employees to save a fixed amount each month for 3 or 5 years, before using the savings (plus any tax-free bonus) to buy shares in the company at a pre-agreed price.
The agreed share price can be lower than the stock’s market price, and the employee will not have Income Tax or National Insurance on the difference between what the shares are worth and what they pay for them.
In addition, the savings interest accrued during the 3 or 5 years is tax-free. However, when the employee comes to sell the shares they will usually be liable for Capital Gaines Tax on any gains.
EMI schemes allow small businesses to award share options to specific employees as part of a remuneration package or bonus, up to a maximum shareholding of £250,000 per employee.
In order to run this type of scheme the company must carry on a qualifying trade (banking, insurance, farming and property businesses do not qualify, for example), it must have a gross asset value of £30 million or less, and it must employ less than 250 permanent staff members.
If the agreed share price on EMI stock options is in line with the company’s market value then the employee will have no Income Tax or National Insurance liability, even if the share price has later risen by the time the option is exercised. In addition, the employee will benefit from Entrepreneurs’ Relief when the shares are sold, which will reduce the Capital Gains Tax liability to just 10%.