Employee share incentives

Share incentives are a popular way to attract, motivate and retain valuable employees.  These could be a direct grant of shares or share options exercisable in future, for example, on a company sale.  The tax implications for the company and the employee vary widely and advance tax advice is recommended.

Approved share option schemes

There are a number of tax advantaged HMRC approved schemes where employee gains are taxed under CGT rather than at higher income tax rates.

Enterprise Management Incentive (EMI) Schemes are popular, easy to establish and flexible.  If set up correctly, the employee only pays CGT on their gains.  With EMI shares, Entrepreneurs’ Relief can be available for less than 5% holdings.

If the company is too large to use an EMI scheme, a Company Share Option Plan (CSOP) can be used which can give a similar CGT treatment for the employee.

Unapproved share option schemes

If an approved scheme cannot be used, unapproved options can be granted, however, these have a higher tax cost for the employee.  The value of the shares when the option is exercised less any exercise price is subject to income tax.  In some cases, particularly when options are exercised on an exit, this tax is due under PAYE with NIC.

Direct issue or transfer of shares

This can give a better tax result than an unapproved option as the difference between the market value of the shares when received and the amount paid is subject to income tax, further commercial increases in value should be subject to CGT.  If shares are issued early or before the company becomes profit-making, the market value is likely to be low.

The shares could be issued at full value but nil or partly paid, so market value is fully “paid” but funding the purchase price is delayed until an exit event. There is no tax charge on receipt of the shares although the outstanding amount is taxed as if it were a beneficial loan.

Employee shareholder Status (ESS)

The employee surrenders certain employment rights in exchange for free shares.  Up to certain limits the shares are tax-free when received.  Gains on sale up to £100,000 can be tax –free.

Reporting and elections

There are annual HMRC on-line reporting requirements for share schemes and other share transactions with employees.  The deadline is 6 July.

S431 ITEPA elections are generally recommended for share acquisitions by employees.  These must be completed within 14 days.