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Does my company need an ESO plan?

“Share options”, “employee share ownership plans”, “share incentive plans” - just some of the expressions you may have heard in recent years, and perhaps wondered whether they have a role to play in your own business.

They are all different ways of describing arrangements to reward employees through the ownership of shares in their company. Participation can be selective - sometimes limited to one or two key people - or extended to all a company's employees.

Whether your approach has been sceptical, enthusiastic, or anywhere on the scale between, you may not have had enough information to consider these kinds of arrangement as thoroughly as you'd like to.

This feature aims to demystify share-based incentives, and enable you to make an informed decision about their relevance to your own business.

Are Employee Share Schemes for the Privileged Minority?

Approximately 12,800 UK companies have a tax advantaged share scheme.

These figures suggest that whilst it is by no means a majority of employees who participate, nor are they a luxury available only to the FTSE 100. There are more private than listed companies operating a share plan, and the number has grown considerably in recent years.

Much of this growth has occurred in the last fifteen years, although legislation to encourage all-employee share ownership in the UK was first introduced in 1978. However, some companies have been practising it successfully for far longer.

In 1897 an obscure parliamentary candidate named Winston Churchill argued that if employees held shares in their employer they would be less vulnerable to lay-offs in bad times and would share in the benefits of good times - an idea that has been given practical application in these more modern times.

Why Introduce an Employee Share Plan?

Companies that have created a share plan will normally say they did so for the following reasons:

  • To provide an incentive and reward directly linked to company performance and which is longer term than a cash bonus 
  • To make the company more attractive as an employer 
  • To encourage employees to stay with the company 
  • Align interests of employees with that of share holders

Do Employee Share Plans Make a Positive Difference

There is plenty of research evidence on this key question, most of which focuses on companies in the UK and the USA, where employee share plans are most common. The clear conclusion is that share plans tend to improve company performance, where the management culture is participative. However, employee share plans are less likely to be compatible with a command and control management style.

Are There Any Tax Incentives for my Company or my Employees?

Yes. There are now four different kinds of schemes benefiting from tax breaks in the UK, two of which were introduced in the Finance Act 2000. The philosophy behind this relatively recent legislation was that:

  • Small, growing companies increasingly need to offer equity to attract their key employees. These companies can't compete with the amounts of cash salary which larger companies offer, and equity rewards for the people whose abilities drive the company's success are essential if the company is to fly as high as it can; 
  • UK companies suffer from inferior productivity compared with those in the principal other European economies. Encouraging companies to make all their employees shareholders will, by partially linking their rewards to their company's performance, provide an incentive for employees to work smarter. 

However, you don't need a tax break to set up an employee share plan, and plenty of companies manage without one, either because they don't meet the statutory conditions, or they occasionally find them too restrictive. Some tax breaks (notably EMI) are less widely available than others, but the vast majority of companies will qualify for a tax-approved plan.

Tax Advantaged Plans - how do the tax incentives work?

Income Tax

  • The common theme between each of the four approved plans is that employees enjoy income tax relief. 
  • For options (CSOP, SAYE, EMI) - gains on exercise of the option are not subject to income tax or NIC unless it is a non-qualifying exercise. 
  • For the Share Incentive Plan: 
  • No income tax on the value of Free Shares, Matching Share and Dividend Shares 
  • Purchased shares (called Partnership Shares) can be bought out of pre-income tax salary 

National Insurance

  • National Insurance can sometimes be payable by your company and your employees on gains made through employee share plans, but the four approved plans are exempt in most cases. 

Corporation Tax

  • Your company can obtain corporation tax relief for the cost of providing Free Shares and Matching Shares under the Share Incentive Plan. 
  • In relation to options, there is also now a statutory corporation tax relief in respect of benefits provided to employees, under the 2003 Finance Act. 

Capital Gains Tax (CGT)

  • Gains made through options will be subject to CGT when shares acquired through option exercise are eventually sold. 
  • As from 6 April 2008, taper relief and indexation allowance has been abolished. The current rates are 18% and 28% for individuals (the rate depends on your total taxable income). Any gains less than the annual exempt amount - £11,000 for the 2014-2015 tax year - are free from CGT. 
  • Gains made on shares whilst held in a SIP are completely free of CGT.

Non Tax Advantaged Plans

The most common type of unapproved share plan is a non tax advantaged share option. This means that any gains made by the employee on option exercise will be subject to income tax (even where these are not yet cash gains because the shares acquired on exercise have not yet been sold), and may also be subject to employer and employee National Insurance. For listed companies, it will often be possible to sell the option shares - or some of them - following exercise, bringing in enough cash for the employee to pay their tax bill. This may also be true where options have been granted over shares in a private company, where exercise coincides with a sale of the Company or its flotation. However, for companies which remain private, you will need to think carefully about how employees who exercise unapproved options and incur a tax bill at that point can raise sufficient cash to pay it.

BT
Equiniti
YBS
Barclays
Capita Asset Services
Computershare
Equatex