Download comparison of employee share incentive structures for SMEs

Share incentives: comparison of alternative employee share incentive
structures for SMEs
INTRODUCTION
The following provides a brief overview of the main features and tax treatment of various equity incentive arrangements available to small and medium sized enterprises. In
particular, we compare enterprise management incentives (EMI), employee shareholder status shares (ESS) and unapproved share options. Please note it does not comment
on the accounting treatment of any of the alternatives or issues of valuation. It is based on the laws and judicial interpretation in force at the date of writing and is therefore
subject to any changes in applicable tax laws and HMRC interpretations occurring after the date of this document.
If, having considered this guide, you would like to know more or to discuss you own circumstances in greater detail, please speak to your usual contact at Stevens & Bolton or a
contact listed at the end of this guide.
Definitions:
CGT
EBT
HMRC
Capital Gains Tax
Employee Benefit Trust
H M Revenue & Customs
NICs
PAYE
National Insurance Contributions
Pay As You Earn
ENTERPRISE MANAGEMENT INCENTIVES (“EMI”)
Key Features
Overview of Tax Treatment
Pros and Cons


Employer
Pros






Tax favoured statutory option
Employees may obtain up to £250,000 of
shares (based on unrestricted value at date
of grant)
Overall scheme limit of £3 million
Option term of 10 years
Bespoke exercise trigger e.g. exit based (i.e.
sale or listing) or performance related
Issuing company must be qualifying at date
of grant and vigilance required that option
remains qualifying throughout the term:
o Independent (not under the control of
another corporate)




If the exercise price is equal to the market value at the date of grant,
employer NICs ought not to be due in respect of the award of shares
If the options are granted at less than the market value or if a
‘disqualifying event’ occurs during the option term, employer NICs
liability may be passed to the employee with employee agreement
Employer is required to notify the grant of an option to HMRC within 92
days
Employer is required to make annual returns
Employer should (subject to statutory requirements) obtain a
corporation tax deduction based on the option profit (market value of a
share at date of exercise less exercise price of option) when the options
are exercised
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



Potentially no income tax/NICs on
increase in value of a share
HMRC will agree a market value of a
share prior to grant
Potential valuable corporation tax
deduction on exercise of option for
employer company
Bespoke option which may be closely
aligned
with
desired
employee
behaviours (e.g. exit)
Entrepreneurs’
Relief
potentially
available to EMI option holders on the

o Gross assets of £30 million or less
o No more than 250 full time employees (or
part time equivalents)
o All subsidiaries are at least 50%+1 owned
o Less than 20% of the business activities
are non-qualifying
Employees are eligible if:
o they work at least 25 hours per week or
75% of their working time on the business
of the grantor company
o hold 30% or less of the ordinary share
capital
Employee



If the exercise price is equal to the market value at the date of grant
and no ‘disqualifying event’ occurs during the option term, no income
tax/NIC will be due on exercise
If there is a ‘disqualifying event’ (e.g. employee leaves employment or a
change in the company/share structure) and the option is exercised
more than 90 days after that disqualifying event, an income tax charge
(and potentially NICs) will arise on the increase in value of a share
between the disqualifying event and exercise
On disposal of the resulting shares, if there is longer than 12 months
between grant and disposal and the option holder remains in
employment with the company, a reduced rate of CGT at 10% applies,
otherwise normal CGT rates apply (10% or 20%)
disposal of shares irrespective of size
of shareholding
 Well understood by employees and
potential purchasers
Cons


EMI must operate within legislative
parameters i.e. qualifying issuing
company, working commitment of
employee
Possibility of post-grant disqualifying
event
EMPLOYEE SHAREHOLDER STATUS (“ESS) SHARES
Key Features
Overview of Tax Treatment
Pros and Cons

Employer
Pros








Employee receives ESS shares in employer
company (or top company in the employer
group) for no payment (paid from reserves)
Employee gives up/adapts rights to the
following:
o Unfair dismissal
o Right to statutory redundancy pay
o Right to request flexible working
o Right to request time off for training
o Notice
period
for
return
from
maternity/paternity/adoption leave
ESS shares must have a tax market value of
at least £2,000 but CGT benefits do not
attach to shares with a value of more than
£50,000
ESS shares do not need to be voting shares
nor carry dividends
Employee and employer enter into a written
statement setting out the terms of the share
grant and any restrictions over the shares
Employee must obtain independent legal
advice on accepting ESS status (paid for by
the employer)
7 day cooling off period between receiving
the independent advice and entering into the
ESS agreement
ESS shares must have a value of not less than £2,000 but not more
than £50,000, employer should pay for a valuation to be agreed with
HMRC
 Employer will be liable for employer’s NICs on any amounts in excess
of £2,000
 Employer will be required to pay for independent legal advice for
employees, which is deductible for corporation tax purposes
 Employer should obtain a corporation tax deduction equal to the value
of the ESS shares provided
 Acquisition of ESS shares reported on Form 42 at the end of the
relevant tax year
Employee



Employee is deemed to have made a payment of £2,000 for the ESS
shares; income tax (and potentially NICs) is payable on any value in
excess of £2,000
No benefit in kind in relation to the employer paying for the reasonable
costs of independent advice
No capital gains tax on the disposal of ESS shares with an initial value
of up to £50,000, capped at £100,000 of gains
Potential exemption from CGT on
disposal of ESS shares up to £100,000
of gains
 ESS shares with a value of £2,000 can
be delivered with no charge to income
tax/NICs
 Added flexibility in workforce due to
waiver of certain employment rights
 It may be possible to reinstate
employment rights in the future without
impacting ESS status
 HMRC will agree value of shares prior
to subscription
Cons




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Employees may be reticent about
giving up employment rights
Any ESS shares in excess of £2,000
are subject to income tax (and
potentially NICs)
Relatively complex procedure to
provide ESS shares
Risk of legislative change

HMRC will agree the market value of the
shares prior to the issue
GROWTH SHARES
Key Features
Overview of Tax Treatment
Pros and Cons

Employer
 No corporation tax deduction for the employer company as the
employee will have paid full unrestricted market value of the shares at
day 1
 If the employee pays the full unrestricted market value of the shares
there will be no obligation on the employer to collect tax on the
acquisition of the shares via PAYE
 If a loan is made to fund the purchase price it may result in tax on any
‘cheap loan’ under the benefit in kind rules
 Employer will need to report the acquisition on Form 42 at the end of
the relevant tax year
Pros




The existing share capital of the Company is
reclassified into different classes of ordinary
shares (e.g. A & B), with the A shares having
the right to participate in the proceeds of any
subsequent sale up to a set value of the
company and the B shares only able to
participate pro rata in the excess above this
level
Employee acquires B shares for cash at the
unrestricted market value at the point of
acquisition
The unrestricted market value is the value of
the shares if all restrictions attaching to the
shares (such as forfeiture or compulsory
transfer
provisions
on
cessation
of
employment) are ignored
Acquisition can either be of new issued
shares or shares held by an EBT
The company/EBT may provide a loan in
order to fund the acquisition cost of the
shares
Employee
 So long as price paid represents unrestricted market value of the
shares at the date of acquisition, and the appropriate tax election is
entered into, there will be no income tax/NIC on the acquisition of the
shares
 Proceeds from the disposal of the shares will ordinarily be subject to
the capital gains tax regime (if market value)
 If a loan is made by the company (or EBT), it may give rise to a benefit
in kind (as a cheap loan – please refer to “Part-paid Share Scheme”
below for further details)



No upfront charge to income tax/NIC
on acquisition of the shares
Total growth in share value will be
subject to CGT
Structurally simple
Cons




Specialist valuation advice required in
order to ensure that the price paid
represents the unrestricted market
value
Total price for the shares must be
provided upfront but may be loaned to
employee
No corporation tax deduction for
acquiring company
Employee acquires shares at day 1 so
all restrictions (on cessation of
employment, etc.) must be included in
the company articles of association
UNAPPROVED SHARE OPTION SCHEME
Key Features
Overview of Tax Treatment
Pros and Cons

Employer
Pros








Options over either a new class of ordinary
shares or exit based arrangements over a
current class of ordinary shares
Usually open to any employee at the
discretion of the directors/shareholders; may
be extended to non-employees
Vesting dependant on the level of sale
proceeds achieved
Flexibility on lapsing criteria, vesting criteria


On exercise, the employer company should (subject to statutory
requirements) obtain a corporation tax deduction equal to the difference
between the exercise price under the option and the market value of a
share at the date of exercise
Employer NICs may be due on the exercise of the option if the shares
are readily convertible assets at that point
Subject to certain restrictions, employer NICs may be passed to the
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
No need for prior HMRC approval
Wide latitude on terms/conditions
No tax on grant of option
The holding of an option is risk free for
an employee
Subsequent growth in value of a share
following exercise will be subject to




and performance conditions
UK market standard to grant options with a
term of 10 years
No limit on individual participation
May be granted at less than market value but
not less than nominal value if it is an option to
acquire new shares
May be granted at less than nominal value if
it is an option over existing shares held in an
EBT
employee by agreement
PAYE to be operated on the exercise of the option if shares are readily
convertible assets
 Employer will need to report the acquisition of shares following exercise
of the option on Form 42 at the end of the relevant tax year
Employee:



capital gains tax
 Can aid employee retention
Cons

Income tax (and NICs via PAYE shares are readily convertible assets)
payable on the difference between the exercise price and the market
value at exercise; if shares are not readily convertible assets then
income tax due via self-assessment
Any subsequent increase in value of the shares following exercise will
be liable to CGT
Tax treatment – employee charged to
income tax (and possibly NICs) on the
difference between the exercise price
of the option and the market value of a
share at exercise
CONTACT US
For further information about any of the issues raised in this guide, please contact:
Kate Schmit
Partner
Jamie Crawford
Senior Associate
+44 (0)1483 406954
[email protected]
+44 (0)1483 406436
[email protected]
The information contained in this guide is intended to be a general introductory summary of the subject matters covered only. It does not purport to be exhaustive, or to provide legal advice, and
should not be used as a substitute for such advice.
© Stevens & Bolton LLP November 2016
Wey House, Farnham Road, Guildford, Surrey GU1 4YD Tel: 01483 302246 Fax: 01483 302254
www.stevens-bolton.com
Stevens & Bolton LLP is a limited liability partnership registered in England with registered number OC306955 and is authorised and regulated by the Solicitors Regulation Authority with SRA number 401245. A list of the
members may be inspected at it registered office.
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