GHP September 2015

ghp September 2015 | 29 funding and investment There are various ways to incentivise staff, but research has shown that share schemes can be a key motivator, for two reasons. First, participation in a share scheme can enable an employee to feel like an owner of the business and this can have a subtle but profound impact on the way they work and their focus on business performance as a whole. Secondly, the promise of a – possibly life changing, or at least life-enhancing - cash reward at some point in the fu- ture, should the business succeed, would make most employees think twice about leaving, especially where a large part of that lump sum may be subject to a low level of taxation. There are various different types of share scheme, some of which can be used if you want to include all of your employees, and others which will be more appropriate where you are planning a reward for a select few. First, though, here is a summary as to how a share scheme works. How a Share Scheme works – and some terminology explained One of the most common approaches, and the one used by most companies for their key or senior employees, is to grant them share options. Instead of being issued with shares directly, your employees (or employee) will be granted a right (an option) to buy shares in the company at a certain point in the future. If those employees decide to buy the shares at that point (exercise their option) the price that they will pay (their exercise price) will be the price agreed at the outset. This will typically be the value of those shares at the date when the option is granted. So, if the share value has risen in the meantime, the employ- ees will buy those shares at what will effectively be a discounted price. If they are able to sell those shares (for example if the company is sold) they will make a profit. (That will be their option gain). Their reward is therefore directly linked to the perfor- mance of the company and the amount by which the shares increase in value. Factors to think about if you want to set up a Share Scheme • Who you want to include. This could be all of your employees or one or more select senior employees. • When the employees should be able to exercise the option and buy the shares. This could for example be upon an exit (a sale or flotation) or after a certain period of time has elapsed. This will depend upon what your long term goals are. So if you are working towards selling the business, you may want to provide that the options can be exercised upon a sale. Or you may be taking a longer term approach with no specific plan to sell your company and be looking to bring your employees into the ownership. • What price you would want your employees to pay for their shares. The exercise price can be the value of the shares when the option is granted, or if, say, you wanted to reward past performance, a lower value. • Whether you want to impose any performance targets. If so, the employee would only be able to exercise their option if they achieved those targets. • How you would want to treat leavers. They may forfeit their options or, in certain circumstances, be permitted to retain them and either exercise them then and there or at a point in the future. Types of Share Scheme and Tax Treatment These can be broadly divided into Tax-Advantaged and non-Tax-Advantaged Schemes (these used to be called Approved and Unapproved Schemes). Another distinc- tion is between all-employee and key employee schemes. For Tax-Advantaged Schemes, the clue is in the name. They carry tax advantages but there are qual- ification provisions for these. Non-Tax-Advantaged Schemes can still act as incentives for employees but any option gains made by employees through Non-Tax-Advantaged schemes will be taxed as income tax (and national insurance may also be payable). The starting point for a smaller business would gener- ally be to consider an Enterprise Management Incentive (or “EMI”) Scheme as these are the most flexible and tax efficient. Employees will only pay tax when they eventually sell their shares and then (provided that the exercise price is no less than the market value of the shares when the option was granted) at CGT rates, which are lower than income tax and National Insurance. As an added bonus, they may also be able to claim entrepreneurs’ relief, which will make the tax rate 10%. Compare that to the income tax rate of 45% for a higher rate taxpayer, and that’s before the addition of employees’ and employers’ national insurance contributions. EMI is however only available to businesses which pass a qualification test. So, for example, your busi- ness would need to employ fewer than 250 employees and have total gross assets of less than £30m. Cer- tain types of business are excluded, although pharma- ceutical companies would generally qualify. You will need to check the position carefully though if much of your revenue arises through the receipt of royalties. If your business doesn’t qualify for EMI, or it is not appropriate for you, there are a number of other schemes which can be considered, including a Com- pany Share Option Scheme (known as a CSOP); an arrangement under which employees can receive free shares if they agree to give up certain employment law rights; and two share schemes for all employees: a Share Incentive Plan (a SIP); or a Save as you Earn Scheme (an SAYE). International companies UK employees can be offered options over shares in a company where the parent company is based overseas. All types of share scheme – including the Tax-Advantaged schemes – are available to compa- nies offering shares in a foreign-owned parent to UK employees, although some special considerations will need to be taken into account. Employees who are based overseas can participate in a UK option scheme, but will only benefit from the tax advantages if they are UK taxpayers. It is often possible to design an employee share scheme that, by being flexible as to how it operates in a given country, is able to take advantage of any tax incentives offered by that particular country. Not all countries do offer tax in- centives for employee share schemes, though, and the United Kingdom provides a suite of tax incentives that will be generally hard to match in most other countries.