Share incentive schemes are an effective way of retaining employees in the short to medium term.
In the majority of share option schemes, employees are not allowed to exercise their option until they have been with the company for a minimum period of three years.
At present there are four types of approved share schemes. These are:
Share Incentive Plans (SIP)
Saving Related Share Option Scheme
Companies Share Option Plans (CSOP)
Enterprise Management Incentives (EMI) Schemes.
The approved shares have a tax and National Insurance Contribution (NIC) advantage. Providing that certain conditions are met the company will be able to award shares to its employees free of tax and NIC.
Typically a company will establish a UK resident trust and will transfer cash into that trust. Cash will then be used to acquire shares in the company.
There are four different ways in which an employee can receive shares under a SIP:
Free shares – an employer can award up to £3,000 worth of shares per annum to participating employees. Awards may be linked to performance, such as the performance of individuals, teams or divisions.
Partnership shares – an employee can buy up to £1,500 worth of partnership shares each year (or up to ten per cent of the income for the tax year if that is less). The shares are bought out of the salary before the deduction of tax and NIC.
Matching shares – an employer can ‘match’ up to two additional free shares for every one partnership share purchased by the employee.
Dividend shares – if an employee receives shares from free, partnership or matching shares the employee can reinvest up to £1,500 per annum of dividend in acquiring new shares.
Before operating the scheme the employer must first obtain HMRC approval. The conditions that have to be met in order to get HMRC approval are:
company must be quoted (any market) or not controlled by another company
the shares must be ordinary shares but the shares can have limited or no voting rights
the employees must be offered shares on similar terms
the scheme must be open to all employees (employee with less than 18 months' service can be excluded)
employees (together with their associates) must not have a ‘material interest’ in the company. Material interest means that they are not able to control more than 25% of the ordinary share capital.
As highlighted above, for all four types of approved share schemes above there is never a charge to income tax or NIC when the shares are awarded to the employees. The future charge, if any, is dependent on the time held as follows:
Free and matching shares – the employer can introduce a clause into the scheme rule to prohibit the withdrawal of the share within three years. If there is no such clause and the employee calls for the shares within three years there will be an income tax and NIC charge at the market value of the shares at the time they were withdrawn. If the shares are withdrawn between three and five years the income tax charge and NIC will be the lower of market value of the shares on allocation and the market value of the shares at the date of withdrawal. If the shares are withdrawn after more than five years there is no income tax or NIC charge at the date of withdrawal.
Partnership shares – unlike free and matching shares the employer cannot prohibit an employee withdrawing the shares from the plan. As with free and matching shares if the shares have been in the plan for less than three years there will be an income tax charge at market value of the shares at the date of withdrawal. If the shares have been in the plan between three and five years, the income tax will be the lower of the ‘salary sacrificed’ to purchase the share and the market value of the shares at the date of withdrawal. If the shares remain in the plan for at least five years, there is no tax or NIC charge at the date they are withdrawn.
Dividend shares – the dividends used to purchase the shares are tax free (the dividends used to purchase the share are omitted from income tax computation in the year in which they are received). The employer cannot prohibit an employee from withdrawing the share from the plan. If the dividend shares are withdrawn within three years, the dividend originally used to purchase the share becomes taxable in the year the shares are withdrawn. There is no income tax if the shares are withdrawn more than three years after purchase.
Capital Gain Tax (CGT) is charged on the difference between the sale proceeds and the value of the shares at the time of withdrawal. So the CGT can be avoided if the shares are sold as soon as they are removed from the trust.