Finding and keeping good staff is key to any successful business, but all the available evidence tells us this is getting harder and harder. Having the right people in the right place at the right time will maximise the value of a company. Enabling employees to share in the value that they create is a tried and tested way to recruit, motivate and retain them. So how do you do it?
Cash bonuses are a simple method, but are tax-inefficient (or, if you prefer, expensive) as they attract income tax at marginal rates and both employers’ and employees’ national insurance contributions. They also fail to carry any sense of ownership.
This is where employee share option schemes, and other share based incentives, come into their own. Properly constructed they can provide substantial and tax efficient rewards, and a feeling among staff that they are part of something greater than the day to day output of the business.
No matter what type of arrangement is used, there is great deal of flexibility in how they are set up. The majority are designed to allow employees a share of the sale proceeds of a business which is then taxed as a capital gain, rather than as income. Some will allow employees to have shares prior to any sale, so that they can be paid dividends or as a taster for a future management buy-out.
Participation in the arrangements can, and is often, made subject to performance targets being met – which can be linked to the financial performance of the business and/or individual employees, or anything else that can be objectively tested.
What type of arrangements are there, and what is best? As ever, it depends. There are some qualifying rules in the tax legislation which may limit the availability of a particular arrangement for a particular business. What is best may depend on what a stage a business is at in its life-cycle.
There are a number of HMRC approved arrangements – for the majority of businesses the most suitable will be an Enterprise Management Incentive Scheme (commonly known as EMI) or, failing that, a Company Share Option Plan (CSOP). Rule changes coming into force in April 2023 are likely to make CSOPs a more attractive proposition than before.
And then there are a raft of arrangements which are not officially approved, but are accepted, by HMRC. These include unapproved share options and the award of growth shares which allow employees to share in the future increase in value of the business. The latter can also be used in an EMI scheme.
For most business that have fewer than 250 full-time equivalent employees and gross assets of no more than £30M (both of which are qualifying conditions) an EMI Scheme will fit the bill best. This can give certainty over tax treatment and as HMRC will agree a company valuation when the scheme is put into place the scope for later arguments is greatly reduced.
How does an EMI scheme work? Typically (but not exclusively) employees will be granted options over a number of shares (or a percentage shareholding) in a company, but those options can only be exercised when the company is being sold. At that point they get shares which they then sell to the buyer of the company. The profit they make is (at current rates) subject to capital gains tax at 20%, but this is reduced to 10% if they have had their options for 2 years or more. The company also gets a corporation tax deduction for their share-based profit, which should be reflected in a higher price paid by the buyer.
