Share option schemes might sound complicated and scary from an employee point of view and we tend to ignore them worrying about tax implications and complexity. This article will hopefully change your mind and have an open mind next time your employer gives you the option. It’s a great way to be part of the firm you are working and has great tax benefits.
There are variety of objectives an employer desires from a Share option schemes, some of them can be incentivising employers, attracting or retaining staff or enhancing remuneration packages.
he outright gift of shares to an employee at less than market value constitutes taxable remuneration in the hands of the employee. The taxable amount is calculated as the difference between the market value of the company’s shares and the price (if any) paid for them and this will be subject to both PAYE and NIC if the shares are tradable.
A more tax efficient way of achieving the transfer of shares to employees is to use one of the four main types of share scheme:
- Approved share option scheme (CSOP);
- Unapproved share option scheme;
- Enterprise management incentives (EMI);
- Share incentive plans (SIPs).
A share option is a right to buy a set number of shares in a company, at a fixed price during a set period. The first three involved share options and the fourth involves the employer giving a fixed number of shares free of tax and NI.
Approved Share Option Scheme
An approved, or “executive” share option scheme, as the name suggests, requires HMRC approval and as such, the rules of the scheme must fall within the HMRC guidelines. They are particularly suitable for family or owner-managed companies because only selected employees need be included.
These schemes operate by granting the participants options to purchase shares in the company at a later date, but with the price fixed at the outset, which is usually the market value of the shares at the date the options are granted.
The granting of options can be made dependent upon the achievement of specific performance targets, but the total value of share options held by a participant at any time cannot exceed £30,000 (based on the market value of the shares at the date the options were granted).
Options can be exercised at any time between three and ten years after they have been granted.
An employee will be eligible to participate in an approved share option scheme if they work for at least 25 hours per week, and do not own more than 25% of the share capital.
Tax Treatment
There is no tax or national insurance charge on the grant of the share option or on its subsequent exercise.
On the disposal of the shares, the capital gain is calculated by comparing the disposal proceeds, to the price paid for the shares when the options were exercised.
On exercise, the company will obtain a corporation tax deduction for the difference between the market value of the shares at that time less any amount paid by the employee for the shares.
Unapproved Share Option Schemes
With an unapproved share option scheme, employees are given options to acquire a number of shares at a future date at any price specified by the company. Such schemes do not require HM Revenue & Customs (HMRC) approval, and the ability to exercise the options may be governed by performance targets.
There is no requirement for all employees to be granted options and the scheme can be set up on a selective basis for certain individuals only.
Tax Treatment
As long as the option has to be exercised within 10 years of its grant, there will be no tax or national insurance charge when the option is granted.
On the exercise of the option there will be an income tax liability on the difference between the market value of the shares at that date, and the price paid for them.
On the disposal of the shares, the capital gain is calculated by comparing the disposal proceeds to the market value of the shares when the options were exercised.
There will be no national insurance charge on the grant or exercise of an option as long as the shares over which the options are granted, are not readily convertible into cash, which means there are no arrangements by which the shares’ value can be realised with certainty.
On exercise, the company will obtain a corporation tax deduction for the difference between the market value of the shares at that time less any amount paid by the employee for the shares.
The main difference between the approved and unapproved schemes is that with an approved scheme there are no tax implications for the employee when the options are exercised – the tax charge is deferred until the shares are disposed of at which point the employee should have the cash to meet the tax liability.
Enterprise Management Incentives
Enterprise Management Incentives (EMI) are intended to help smaller companies with potential for growth to recruit and retain high calibre employees and to reward employees for taking a risk by investing their time and skills in helping small companies to achieve their potential.
Available to small high risk independent trading companies which are not under the control of any other company, and whose gross assets do not exceed £30m.
There is no limit on the number of key employees that can be given options to acquire shares in the company, at, or less than, the market value of the shares at the date the options are given to them. The total value of the options given to each employee cannot exceed £250,000 (£120,000 up to 16 June 2012), with an overall total of £3,000,000; and they must be exercised within 10 years.
Voting restrictions can be placed over the shares subject to options to protect the owner-managers’ position. The company can choose exactly who receives the option (subject to the material interest barrier) and they can be granted conditionally subject to performance criteria.
The company must notify HMRC within 92 days of the options being granted and the market value of the shares has to be agreed with the HMRC – Shares & Asset Valuation Division.
Formal HMRC approval is not required, but it is possible to obtain advance clearance that the company (not the employees) will meet the EMI qualifying requirements.
An employee will be eligible for EMI options if they are employed by the company for at least 25 hours a week, or if less, for at least 75% of their working time, and do not own more than 30% of the share capital.
Tax Treatment
There is no tax or national insurance charge on the grant of the share option. Similarly, there will be no tax or national insurance charge on the exercise of an option unless the option was granted at less than market value, in which case there will be charge to income tax on the difference (collected through the PAYE system).
When the shares are sold, any capital gain arising will qualify for Entrepreneur’s Relief, provided the employee owns at least 5% of the issuing company’s share capital, and has done so for at least a year.
On exercise, the company will obtain a corporation tax deduction for the difference between the market value of the shares at that time less any amount paid by the employee for the shares.
Share Incentive Plans
A Share Incentive Plan (SIP) is designed to be flexible so that all employees can participate and employers can reward specific performance. Shares acquired under the plan have to be held in a UK resident trust to ensure the independent legal ownership of the shares.
Employers can give employees up to £3,000 of shares each year free of tax and national insurance (“free” shares). Some or all can be awarded based on performance targets.
Employees can buy up to £1,500 of shares out of their pre-tax and pre-NIC salary (“partnership” shares).
Employers will be able to match partnership shares by giving employees up to two further free shares for each partnership share (“matching” shares) up to a maximum of £3,000.
Up to £1,500 of dividends may be reinvested in shares tax-free each year. Shares must leave the plan when the employees leave their job. The company can decide whether employees lose their free shares if they leave within 3 years.
The company will obtain corporation tax relief for the costs they incur in providing shares and also for the market value of the free and any matching shares given to the employee.
The company must offer all employees the opportunity to participate in the plan whether they work full or part-time, although a minimum period of employment can be specified before an employee can qualify (this cannot exceed 18 months).
Tax Treatment
Employees who keep their shares in a plan for 5 years pay no income tax or national insurance on those shares and there will be no capital gains tax on sale.
Employees who take their shares out of the plan after 3 years will pay income tax and national insurance on only the initial value of those shares – any increase in the value of their shares while in the plan will be free of income tax and national insurance.
Employees who keep their shares in the plan until they are sold will have no capital gains tax to pay on sale. If they take the shares out and sell them later then there will only be a charge to capital gains tax on any increase in the value of the shares after they have been taken out of the plan.
Which Scheme is for you?
Because HMRC approval is not required, Unapproved Share Option Schemes provide maximum flexibility along with the ability to individually tailor the rules of the scheme to meet the company’s requirements; the exercise price can be set below the market value of the shares, which gives immediate value to the option. There is, however,
an income tax liability when the option is exercised, which may mean the employee has to sell some of the shares just acquired in order to meet this liability; although in some cases, the employer will pay the employee a bonus sufficient to fund the income tax liability.
By way of contrast, Approved Share Option Schemes are much less flexible because they have to meet certain statutory requirement. The exercise price of the shares cannot be less than the market value and there is a £30,000 limit on the value of the options that can be held by an individual at any one time. The main advantage of approved schemes is that there is no tax charge when the option is exercised – the only tax charge arises when the share are sold which means the employee will have cash to meet the tax liability.
Also, the increase in value of the shares between the granting and exercise of the option, which is subject to an immediate income tax charge with an unapproved scheme, is effectively taxed as a capital gain when the shares are sold, against which the individual can utilise his annual capital gains tax exemption.
The Enterprise Management Incentive Scheme (EMI) is highly tax advantageous because there is no tax or national insurance when the share options are granted or exercised. Capital gains on EMI option shares are likely to incur a maximum Capital Gains Tax (CGT) rate of 28% (after deducting the annual exemption). The lower 18% CGT rate would only apply if the employee has not used their basic rate income tax band (unless the employee holds at least 5% of the issuing company’s share capital and does so for at least a year, they will not benefit from the 10% Entrepreneur’s Relief CGT).
We at Outsourced ACC can assist you with selecting the right scheme or advising you receiving such options how best you can manage and receive the maximum tax benefit. We also provide a range of consulting services in advising our clients on the best share option scheme which is included in our fixed annual fee when you sign up with us.