With the economy in turmoil, many companies are exploring different ways of tightening their fiscal belts. Measures such as pay freezes, redundancies, reduced working hours and reducing or eliminating cash bonuses may help initially in cutting costs, but do little to attract, motivate and retain top performers and critical-skill workers.
Employee share schemes are a flexible way of rewarding staff for past efforts and incentivising future performance.
The tax savings available to employers and employees under approved share schemes are increasingly valuable to employers now that we know employer National Insurance contributions (NICs) will be increased to 13.3% from 6 April 2011, and attractive to employees given that the new standard employee NIC rate will be 11.5% (not forgetting otherwise fortunate high earners who will have a new 50% top rate of income tax from 6 April 2010).
Even better, share schemes can be implemented and operated at low cash cost to the employer, and research shows they can improve company performance by providing employees with a long term interest in the performance of the company’s shares and aligning them with the overall success of the company.
What are employee share schemes?
There are many types of share schemes, but generally they involve granting employees shares in the employer company, or the right to acquire such shares, at a beneficial price.
If an employer implements a share scheme approved by HMRC, there are tax advantages. Approved schemes are Share Incentive Plans and Save As You Earn schemes (which can both only be offered to all employees), Company Share Option Plans and Enterprise Management Incentive options (which are both discretionary).
What are the potential cash savings?
If a company can satisfy employee share schemes using newly issued shares, providing the shares has no cash cost for the company. By comparison, bonuses take cash out of the company equal to the intended employee benefit, plus employer NICs.
Share schemes offer a more flexible approach than other forms of remuneration. For example, if a company raises an employee’s salary and company profits decrease the following year, it would be difficult to then reduce the employee’s salary without risking a claim of constructive dismissal. However, when a company grants discretionary options one year, it is under no obligation to do the same the following year or at the same level or with the same conditions.
Share schemes enable participating employees to profit from current low share prices in a gentler way than investing on the stock market. Options present no upfront risk to participants (who can simply choose whether or not to purchase shares through exercising options). Under a SIP a basic rate taxpayer can get a discount of up to 31.5% (20% income tax + 11.5% NIC from April 2011) when purchasing shares in their employer, so even in a volatile market this could still work out well over the next 5 years (obviously employees need to consider the risks carefully and should take independent financial advice before investing).
What are the potential tax savings?
Share Incentive Plan (SIP)
In a SIP, employees buy "partnership" shares worth up to £1,500 each tax year directly from their employer from gross salary, which the employer can choose to match, giving up to two matching shares to each share purchased by an employee. Employees can also use the dividends from the shares to purchase additional shares tax free up to a value of £1,500, and employers can choose to grant up to £3,000 worth of additional free shares too. In the recession, we would expect employers to offer partnership shares but probably not many of the additional types of shares.
No income tax or employee or employer NICs are payable if the shares are held in the SIP for 5 years.
If an employee holds the shares in the SIP for at least 5 years, he or she can sell them free of Capital Gains Tax (CGT).
Save As You Earn plan (SAYE)
Under the SAYE plan, employees enter into a special savings contract for a period of 3 or 5 years and receive a tax-free bonus instead of interest on the savings. At the end of the savings period, the employee can use the money in the savings account to exercise an option to buy shares in the company at a price set at the time the employee entered into the contract (this is usually the market value at that time but can be discounted to as low as 80% of the market value). Alternatively, the employee can choose to take the money out tax-free.
When the employee sells shares acquired under an approved SAYE option, the capital gain is calculated as the sales price less the acquisition price. Gains that exceed the annual exemption (currently £10,100) are taxed at 18%.
This is the most popular type of approved employee share plan, currently operated by 3,000 companies.
Company Share Option Plan (CSOP)
Under a CSOP, a company may grant any employee (or director) an option to purchase up to £30,000 worth of the company's shares at a set time in the future at today's price.
No income tax or employee or employer NICs are payable when the option is granted or when it is exercised, provided the employee waits at least 3 years from the date of grant.
When the employee sells shares acquired under an approved CSOP option, the capital gain is calculated as the sales price less the acquisition price (or the amount taxed at exercise, if the exercise is unapproved). Gains that exceed the annual exemption (currently £10,100) are taxed at 18%.
Enterprise Management Incentive (EMI) schemes
An EMI option of up to £120,000 may be granted to "full-time" employees and directors, subject to a total share value of £3 million under EMI options to all employees. The scheme is aimed at helping smaller independent entrepreneurial companies with gross assets of £30 million or less to recruit and retain high calibre employees.
The tax treatment of EMI options is the same as for CSOP options except that there is no waiting period required for EMI options.