Employee share schemes and options

Companies often use employee share schemes to remunerate and incentivise staff.  The share schemes give employees either a stake in the company or share options to invest in the company.  This means that the more profitable the company is the more likely it is that the employees will get a better return on their investment.  Shares and options issued under share schemes can also have tax breaks for the recipients if they meet certain criteria.

Benefits of employee share schemes

There are a number of benefits to the company from employee share schemes which will benefit the other shareholders despite the dilution of their holdings.  The benefits include:

All of these benefits should lead to an improved company performance which should benefit existing shareholders as well as the employees.  Meaning that all parties will benefit from employee share schemes.

There are also benefits to the employees, especially where tax advantaged share schemes are used.

Types of share scheme

There are a number of share schemes that provide tax breaks, either for investors in shares or for options available to employees of the company.

The main employee share schemes offering tax incentives are:

1. Enterprise Management Incentives (EMIs)
2. Company Share Option Plans (CSOPs)
3. Save As You Earn (SAYE)
4. Share Incentive Plans (SIPs)
5. Employee shareholder shares – ceased to apply to new share issues from 1 December 2016

In addition, companies may run unapproved share option schemes and can issue free shares to employees, but these provide no tax breaks to employees.

Before setting up a specific type of employee share scheme companies will need to consider the following:

• Who the options will be granted to – all employees or only a section of employees;
• The number of options to be granted;
• The purpose of the scheme – reward for work to date or to incentivise future work;
• The size of the company and its activities – certain schemes have restrictions around these;
• The planned exercise price and dates when exercisable – again certain schemes have restrictions or requirements around these; and
• Whether the shares are quoted or there is a market for them to allow employees to realise any profits.

Companies can also grant options to investors but these provide no tax incentives for the investors.

The main schemes offering tax incentives available for investors in companies are:

1. Enterprise Investment Scheme (EIS)
2. Seed Enterprise Investment Scheme (SEIS)
3. Social Investment Tax Relief (SITR)

The below sections provide a brief overview of each of the employee share schemes and investor share schemes in turn.

Employee share schemes

Enterprise Management Incentives (EMIs)

Under this scheme companies, other than companies carrying out certain excluded activities, with assets of £30 million or less and less than 250 employees can offer Enterprise Management Incentives (EMIs) to certain of their employees.  The excluded activities include:

• banking
• farming
• property development
• provision of legal services
• ship building

Where companies issue EMIs they can grant share options up to the value of £250,000 to each employee in any three year period subject to having a maximum of £3 million EMIs granted amongst all employees.

The exercise price is as set by the company, which may be at the then market value or a discount to the market value.

If the exercise price was at or above the market value of the shares (as agreed with HMRC) at the grant date, then neither income tax nor National Insurance are payable on this difference. However, if the exercise price was less than the market value of the shares at the date granted, then income tax and national insurance are payable on the amount by which the market value of the shares at the date exercised is more than the exercise price.

When the shares are sold then any gain over the original purchase price will be subject to capital gains tax.

Company Share Option Plan (CSOP)

A Company Share Option Plan (CSOP) allows qualifying companies to grant options to employees to buy up to £60,000 (effective from 6 April 2023 and previously was £30,000) worth of shares each at a fixed price.  The fixed price is the market value of the shares at the time that the options are granted as agreed with HMRC.

Then, provided the options are exercised within ten years of being granted and:

• 3 or more years after the date of grant; or
• within 6 months of leaving employment under certain circumstances; or
• within 12 months of the employee’s death; or
• within 6 months of the company being taken over

When exercised neither income tax nor National Insurance are payable on the difference between the market value at the date of exercise and the price paid for the shares.

When the shares are sold then any gain over the original purchase price will be subject to capital gains tax.

Save As You Earn (SAYE)

This scheme allows employees of companies to invest an amount each month out of monthly pay of up to £500 in an interest-bearing savings account over three or five years.  At the end of the period the employee can buy shares in their employer at the fixed price set at the beginning of the contract or take the cash plus any interest and bonus paid.  The exercise price can be set at up to a 20% discount to the market value at the time of grant as agreed with HMRC.

The interest or any bonus paid at the end of the contract is free of tax.

If the shares are taken up and the current value is more than the price paid, then neither income tax nor National Insurance are payable on this difference.

When the shares are sold then any gain over the original purchase price will be subject to capital gains tax. However, in the following circumstances deemed gains will not be subject to capital gains tax:

• Transfer to an Individual Savings Account (ISA) within 90 days of buying the shares (the maximum that can be transferred is shares with a current value of the previously unused annual savings limit); or
• Transfer to a pension on the day that the shares are bought subject to the annual pension contribution limit.

Share Incentive Plans (SIPs)

Under a SIP employees can receive shares on various bases:

• Free shares worth up to £3,600 can be given to each employee;
• Partnership shares bought using gross pay at market value;
• Matching shares of up to two for each share bought can be given by the company;
• Dividend shares: reinvestment of dividends received on SIP shares in further shares at market value.

The free and matching shares are often lost if the employee leaves within three years of being given them.

If the shares are held in a SIP for at least five years, then neither income tax nor insurance is payable on their value.  In addition, if the shares are sold directly from the SIP after five years any gain is not subject to capital gains tax.

Employee shareholder shares

To be an employee shareholder, a person must own shares in their employer that were worth at least £2,000 when obtained.  Employee shareholder status only applies to relevant shares obtained free before 1 December 2016.

Employees with such shares might not pay capital gains tax when selling the shares. This depends on the date that the employee shareholder agreement was signed.

If signed before 17 March 2016, then capital gains tax is payable on the element that had a market value of over £50,000 when received.

If signed on or after 17 March 2016, then capital gains tax is only payable on gains over £100,000 made on those shares during the employee’s lifetime.

Investor share schemes

Enterprise Investment Scheme (EIS)

The Enterprise Investment Scheme (EIS) provides both income tax and capital gains tax reliefs for the investors as follows:

• income tax relief on 30% of the EIS investments made in that tax year on up to £1 million (or £2 million if at least £1 million of that is invested in knowledge intensive companies), of which up to £1 million can be carried back to the previous tax year.
• capital gains tax relief on 100% of the investment up to £1 million provided that income tax relief was received on the investment and the shares have been held for at least three years.
• if a loss is made on the investment which is more that the initial income tax relief this can be offset against income tax.
• capital gains tax deferral on gains from the sale of other assets if the proceeds are invested in EIS shares.
• inheritance tax exemption if the shares have been held for at least two years.

To issue EIS shares the company has to comply with certain criteria including:

• up to £5 million capital raised in one year with an overall maximum of £12 million within seven years of its first commercial sale
• follow the EIS rules for a minimum of three years from investment
• carry out a qualifying trade
• have 250 or less employees
• have gross assets of £15 million or less
• use the funds in specified ways within two years of investment or starting to trade
• have a permanent establishment in the UK

Seed Enterprise Investment Scheme (SEIS)

The Seed Enterprise Investment Scheme (SEIS) is similar to the EIS.  However, under SEIS investors get:

• income tax relief on 50% of the SEIS investments of up to £100,000 made in that tax year;
• capital gains tax relief on 50% of any gains (up to £50,000) on the sale of other assets where the proceeds have been reinvested in SEIS shares.

The rules for the company are similar to those for EIS other than:

• the maximum amount is £150,000
• have gross assets of £200,000 or less
• have less than 25 employees
• not a member of a partnership
• the qualifying trade has not been carried out for more than two years.

Social Investment Tax Relief (SITR)

Social Investment Tax Relief (SITR) is specifically aimed at supporting people who want to invest in charities, community investment companies (CICs) and community benefit societies.

It does this by offering investors income tax and capital gains tax relief in the same way as EIS investments.

As for EIS and SEIS investments the social enterprise invested in has to meet certain criteria, including:

• carrying out a qualifying trade
• have gross assets of £15 million or less at the time of investment and not more than £16 million after investment
• receive a maximum of £1.5 million under SITR
• have 250 or less employees
• not be controlled by another company

Unlike EIS and SEIS the investment does not have to be in new shares but can also be a loan under a new debt investment.