RECENT improvements to the statutory rules for tax-advantaged employee share plans have, in their different ways, the potential to make employee share plans attractive to more private companies.
Share plans are very often the first port of call for a company looking to reward its key people through growth in share value and create a strong incentive for them to stay. Enterprise management incentive (EMI) options combine high flexibility with a beneficial tax treatment for participants, who pay capital gains tax (CGT), rather than income tax and National Insurance, on any financial gains.
Headline CGT rates are 18% (basic-rate taxpayer) or 28% (higher- or additional-rate taxpayer), but a change to the EMI tax rules now means that an employee who sells shares acquired through EMI options can claim entrepreneurs’ relief, whatever the size of shareholding. The general entrepreneurs’ relief requirement for the holding to be at least 5% does not apply to EMI optionholders.
Other conditions apply, including the one that at least one year must have passed between option grant and sale of the shares.
EMI is only available to smaller companies – those with fewer than 250 full-time employees or gross assets of up to £30m, with qualifying trades. Companies that do not qualify to grant EMI options might look instead at Company Share Option Plan (CSOP) options.
These work in a similar way to EMI options, although they are less flexible. Unfortunately, they do not benefit from the special deal on entrepreneurs’ relief given to EMI optionholders, but relaxations of some of the other rules increase their attractiveness as an alternative to EMI (where, for example, a company’s trade makes it ineligible to grant EMI options). In particular:
• It is no longer required (or even possible) to obtain prior HM Revenue and Customs approval before a company may operate a CSOP. This can make the set-up process up to six weeks faster;
• While the minimum period allowed to exercise CSOP is normally three years, earlier exercise is now permitted without tax penalty if the company is taken over under a cash offer; and
• Rules which prevented a company using a special class of shares for CSOP options have been removed. These have often made it hard for private companies to grant CSOP options, as they typically want shares acquired through CSOP options to be sold if their holder leaves, without imposing a similar obligation in relation to founders’ shares.
Share incentive plans (SIPs)
SIPs are the all-employee share ownership plan under which employees are given income tax relief to purchase shares in their employer and/or may receive free shares without being taxed on the value. Any growth in share is free of CGT.
As well as benefiting from the same changes enjoyed by CSOP – outlined earlier – an additional change allows any shareholder in a company who is also an employee to participate in an award of shares under a SIP. Previously, any person holding 25% or more of their company’s shares was ineligible. This change may encourage a company’s principal shareholders to acquire further shares through a SIP.
Increased annual limits also now apply the value of the total amount that is potentially subject to tax relief at £9,000 (£1,800 for purchased shares; £3,600 free shares; up to two additional free matching shares for every one share purchased). The previous limit was £7,500.
Somewhat confusingly named, this is a very specific facility under which an employee may be granted free shares, tax free, in their company, with a minimum value of £2,000, if they agree to give up certain employment rights (principally rights to unfair dismissal and redundancy payments). The company can choose to award shares with a higher initial value, but they will pay income tax on the excess. Any subsequent growth in share value is exempt from CGT, so long as the initial value is not more than £50,000.
Employee ownership trusts
Two new tax reliefs have also been created in 2014, intended to encourage more companies to become employee-owned. These work as follows:
• Company owners who sell a controlling interest to an employee ownership trust can claim full exemption from CGT; and
• A company controlled by an employee ownership trust may pay annual bonuses to employees, free of income tax.
Some key conditions apply, of which the main one is that the trust must exist to benefit all employees on the same terms and that any income-tax-free bonuses are subject to the same requirement (although “same terms” does allow variations based on salary, length of service and/or hours worked).
Robert Postlethwaite is managing director of Postlethwaite, solicitors specialising in employee share plans and employee ownership