Will Santa be bringing shares for your employees this Christmas?

30 November 2023

As the festive season approaches, employers may be wishing to stay on Santa’s nice list by offering rewards and incentives to key employees. A method of doing so is to award shares to employees. This can aid with retention and incentivise employees to grow the business in line with its objectives. 

As the acquisition of shares or other securities would be by reason of the employee’s employment, the shares would be treated as employment related securities (ERS). Under the ERS rules, a simple gift of shares by an employer could result in immediate income tax and in some cases national insurance (NIC) liabilities for both employee and employer. This liability, based on the market value of the shares at the date of award, could impact the incentivisation aspect of the share awards. After all, who wants an unwanted tax bill in their stocking alongside their shiny new shares? The structure of the share awards is important to ensure that it rewards and incentivises the employees as desired. 

There are various ways to structure share awards tax efficiently, some of which are summarised below.

HMRC-approved employee incentive plans

Thankfully, HMRC doesn’t always exhibit its inner Ebenezer Scrooge as there are a number of HMRC-approved employee incentive plans with generous tax breaks for employees and employers. 

The most popular HMRC-approved incentive plan is Enterprise Management Incentive (EMI) options. With an EMI an employer can grant employee options over shares with a value of up to £250,000 at the date of grant for an agreed exercise price. This allows the employee to exercise their options and acquire the shares at a specified time, eg an exit such as a sale or IPO or when performance conditions are met. There should be no income tax or NIC liabilities for the employee or employer if the exercise price is at least equal to the market value of the shares under option at the date of grant (subject to the other EMI qualifying conditions being met). For example, an employee could receive EMI options with an exercise price of £100,000, being the market value at the date of grant, but at the date of exercise, the shares are worth £200,000. In this scenario, the employee has acquired shares worth £200,000 for £100,000, free of tax and NIC. 

Employees are often taxed at 10% on growth in the shares’ value when they are sold by the employee, as opposed to the current 20% capital gains tax rate. The employer company also benefits from a corporation tax deduction equal to the gains made by the employee. 

Where an EMI scheme isn’t suitable or the qualifying conditions cannot be met, an alternative could be a Company Share Option Plan (CSOP). The CSOP works in a similar way to an EMI scheme, but with fewer conditions for participating companies, opening up the CSOP to more businesses. One of the main differences between a CSOP and EMI plan is that the employee can be granted options over shares valued up to £60,000 at the date of grant under a CSOP as opposed to £250,000 under an EMI plan. In addition, there is no reduced rate of capital gains tax for the sale of shares acquired via a CSOP with the normal rate of up to 20% typically applying. CSOPs may be more enticing for businesses than previously; although the individual limits are less than for EMI, they have recently doubled and CSOPs also bring less restrictive conditions on the types of shares which can be used than was previously the case.

Share incentive plans (SIP) and Save As You Earn (SAYE) are further examples of HMRC-approved employee incentive plans. A SIP would allow a company to provide shares to employees. For each employee, up to £9,000 worth of shares annually (plus unlimited reinvestment of dividends) are potentially free of tax and NIC. The employer may also qualify for a possible corporation tax deduction.

Under a SAYE share option plan, employees may pay monthly, via payroll, into a bank or building society and can use those savings to buy shares through an option scheme or can withdraw the savings for other uses. Both the SIP and SAYE are all-employee plans and can be used to incentivise the wider workforce. EMI and CSOP are discretionary so employers can be selective with the employees that benefit from EMI and CSOP.

Unapproved employee incentive plans

Employee incentive plans can also be structured tax efficiently without being HMRC-approved. One key example of this is growth shares.

Growth shares allow participants to acquire shares with low initial rights and value but with the opportunity, if specific events or hurdles are achieved, of benefitting from the growth. The growth in value of the growth shares is typically taxed as a capital gain instead of employment income. As a result, growth shares benefit from the lower capital gains tax rates as opposed to being subject to income tax and NIC.

Growth shares can benefit companies with high growth potential and can be a tax efficient method of incentivising employees to aid the business with its growth objectives. Unlike the HMRC-approved incentive plans, there are no statutory conditions required to be met when structuring the growth shares. For the company, this means more flexibility to structure the plan to fit with its objectives and culture.

Another example is where shares are issued nil paid. This is where ordinary shares (or growth shares) can be issued for their full market value but the subscription price to be paid by the employee can be deferred until the occurrence of specific events (such as an exit). The benefit of nil paid shares is that any growth in value should be treated as a capital gain and not employment income (similar to the growth shares). However, the employee would be liable to pay the subscription price on a liquidation of the company. 

Don’t forget…

There are reporting obligations for employee incentive plans, with annual ERS returns required to be filed by 6 July after the end of each tax year. There are also important obligations to notify HMRC in relation to an HMRC-approved incentive plan. Non-compliance can result in hefty fines, potential disqualification of the HMRC-approved incentive plan and unexpected tax / NIC charges. Bah humbug!

If you would like more information or have any queries about the areas mentioned above, please contact Martin Cooper.