Many employers offer employee share schemes to attract and retain top talent by ensuring both employee and employer interests are on the same path.

With strict and detailed HMRC legislation to adhere to, however, it is important to fully plan an employee share scheme before it is put into place to ensure tax compliance.

So how do employee share schemes work? Simply put, an employee share scheme offers company shares to employees at a set price within a defined time period, under either an approved scheme or an unapproved scheme.

Approved schemes, including Save As You Earn (SAYE), company share option plans (CSOP), share incentive plans (SIP), and Enterprise Management Incentives (EMI), are generally a tax efficient option because due to HMRC approval of the scheme, employees may not have to pay related income tax or national insurance.

Unapproved schemes, including long term incentive plans and growth share plans, that are without HMRC approval, do not benefit from the same tax relief, although they may still offer a level of tax efficiency.

Each category of scheme has its own rules and suitability and as such, it is always advised to take professional advice before entering into one, whether as an employee or an employer.

Unapproved employee share schemes

Under an unapproved employee share scheme, employees may be given the option to purchase shares in their employing company at an agreed price in the future.

An unapproved employee share scheme may be selective, in that shares are offered to specific employees, or a specific category of employee, only.

The potential to an employee of becoming a shareholder in their company is often used by employers as a motivation tool to achieve performance targets.

Unapproved employee share schemes do not carry the approval of the HMRC and the related tax benefits, however, they do offer more flexibility and control to the participating company than an approved scheme.

An unapproved scheme could be put in place where a company cannot comply with HMRC share scheme approval rules, such as the scenario where an employer wishes to grant share options in excess of those allowed in an approved scheme.

Where the share option has been exercised by an employee within ten years of it being offered, there will generally be no tax or national insurance liability.

It is possible to set the share price below the market value, but this will incur income tax when the share option is exercised. One option is for the employee to sell some of their newly acquired shares to pay this liability, however, many employers will make a bonus payment to cover this charge.

Capital gains tax may be incurred by the employee should the shares be disposed of at a profit. This will be calculated by comparing the sale price of the shares with the market value of the shares when they were originally acquired by the employee.
The choice of whether to set up an unapproved scheme, and in what form, will depend on the circumstances of the company and the aims of the scheme. This is a complex decision to make and it is always advised that professional advice is sought.

There are several options on what form the unapproved scheme could take, including:

Growth share plans

This form of plan is employed to reward particular members of staff for an increase in the company’s value. The employee is offered shares in their employing company, without investment, that will only provide income or dividends once the value of the company passes a specified amount.

Generally, a growth share plan is tax efficient for participating employees in that it does not incur income tax or national insurance.
Long term incentive plans (L-TIPs)

These free shares are used to reward particular members of staff for achieving their performance targets and to retain them as an employee.

The shares are held in an Employee Benefit Trust which is arranged and overseen by the company. When an employee achieves their performance target, they have the option to:

  • allocate the shares,
  • transfer the shares,
  • sell the shares, or
    take beneficial ownership of the shares.

Should the employee not meet their performance targets, or leave before their performance targets have been achieved, they will lose the L-TIPs benefit.

Employees will generally incur income tax on any L-TIPs they own, and there may also be a national insurance implication for both the employee and the employer. Finally, there may be deductions against chargeable profits in the context of corporation tax.

Entrepreneurs’ Relief

When disposing of shares, Entrepreneurs’ Relief can be used to reduce the capital gains tax calculation from 18% to 10%, chargeable after taking into account the employee’s tax free allowance, £11,700 as at February 2019.

An employee may only use Entrepreneurs’ Relief for gains up to a maximum of £10 million. Once that amount of gains has been claimed for, this type of relief can no longer be used.

Eligibility for Entrepreneur’s Relief relies on the following:

  • the shareholder owns a minimum of 5% of the company’s ordinary shares and has a corresponding voting power
  • employment with the company, or an office holder of the company such as a company secretary
  • the company is largely a trading company or a holding company of a trading company
  • the shareholder has owned the shares for a minimum of one year

The factor of 5% ownership of the company’s ordinary shares and corresponding voting power means that Entrepreneurs’ Relief generally isn’t available to employee shareholders, although this may not always be the case.

Approved employee share schemes

Due to the fact that these types of schemes carry HMRC approval, they must comply with the related statutory laws. The benefit of an approved scheme, however, is that no tax is incurred at the point of the share option being exercised. It is only if the shares are sold, that tax may become liable.

There are numerous approved share schemes available:

Company share option plans (CSOP)

Under this type of scheme, share options are offered to employees at a set future date. The shares are offered at market value and granting of the share options may be dependent on the employee meeting performance targets. Share options up to £30,000 in value may be offered.

Any CSOP must receive approval by HMRC and agreement to the market value of the shares being offered.
CSOPs are discretionary and targeted at particular members of staff, leading to the popularity of this type of employee share scheme with family or owner-managed companies.

CSOPs are not available to employees owning over 25% of the company.

Share options must be exercised between three and ten years after being granted. Generally, income tax and national insurance will not be incurred as long as the share options are exercised after three years, although capital gains tax will come into play should the shares be sold.

Enterprise management incentives (EMI)

EMI schemes are generally best suited to:

  • small, independent companies
  • companies with gross assets valued at £30 million or less
  • companies who have 250 employees or less

EMI schemes are intended to be used as a tool for smaller companies to attract top talent individuals and keep them in their employ.

Approval from HMRC is required for an EMI scheme but it is not necessary to obtain that approval before setting up the scheme.

Instead, HMRC must be informed no later than 92 days after each share option is granted.

Save as you earn (SAYE)

SAYE schemes must be HMRC approved and made available to all employees under the same rules and conditions, allowing employees to pay into a savings scheme with the intent of using those savings to later pay for company shares.

Employees agree to a savings contract for a period of three or five years, with the chance to save up to £500 each month. The amount paid into the savings scheme is taken straight from the employee’s monthly salary payment after deductions.

The advantage of an SAYE scheme to an employee is that any interest or bonus earned by the end of the scheme are tax free, and no income tax or national insurance is incurred by the difference between the price the employee paid for the shares and their value.

Should the employee sell the shares, there may be capital gains tax to pay, unless the shares are placed in a pension at the point of purchase or in an individual savings account (ISA) no later than 90 days after purchase.

Share incentive plans (SIP)

An employer with a SIP scheme in place may annually award up to £3,600 of free shares to employees, with no income tax or national insurance liability.

Where a company has a SIP scheme in place, it must be offered to all their employees. However, it is possible for an employer to state that the SIP will only be offered once an employee has worked for the company for a set period of time, at a maximum of 18 months.

An employee can purchase up to a maximum £1,800 of partnership shares from their salary before deductions. The employer may also offer up to two matching partnership shares, tax free, for each one share purchased by the employee.

Employees may also buy more shares from the company using dividends received from the free, partnership or matching shares they own. This arrangement is not required by HMRC, however, and must be agreed by the company itself. Where dividend shares are retained for at least three years, income tax will not be incurred.

Where there is a SIP in place, a company will be eligible for corporation tax relief for the cost of any free or matching shares given to employees, and the cost of making the shares available.

Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.

Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.

Before acting on any of the information contained herein, expert legal or other advice should be sought.

As Editor of Taxoo, Gill is passionate about helping people and businesses make better financial decisions. She is a content specialist in the fields of tax, law and human resources.