How to incentivise employees to grow your business
Read time: 5 mins
Publication: Article As a business grows, it is important to retain key employees and align their objectives with those of the company.
Including them in a share of the growth and profits, outside of their bonus, can help to incentivise them. However, it is important to understand how this affects them from a tax perspective.
Enterprise Management Incentives (EMIs)
The EMI scheme is available to smaller companies — those with fewer than 250 employees and assets of less than £30m.
Under EMI, in any 3-year period you can grant options of up to £250,000 to each employee. The total limit on options granted under EMI is £3m., Consider the restrictions which will determine who of your employees qualify as EMI provides beneficial tax treatment.
No Income Tax or National Insurance is payable on the grant or exercise of options under EMI. However, Capital Gain Tax (CGT) will be payable on the disposal.
If an employee is granted the options more than two years before sale, they will probably qualify for Business Asset Disposal Relief (BADR), formerly called Entrepreneur’s Relief (ER), which can reduce their CGT liability from 20% to 10%.
In most cases, EMI option holders end up paying CGT at 10% on the gain realised on their options.
Before granting options under EMI, it is possible to get an advanced assurance from HMRC that your company will qualify. You can also agree the market value of the shares with HMRC.
Company Share Option Plan (CSOP)
CSOP is the “little brother” of the EMI scheme and has more flexibility.
Under the plan, employees can be granted up to £60,000 of options, which must be offered at market value with no discount.
In some cases, there can be no tax implications, e.g. when employees exercise their options within a 3- to 10-year window following the grant date. If they exercise their options outside of that window, Income Tax and NICs will become due, collected through PAYE.
Unlike EMI, employees are unlikely to qualify for BADR. This is because under the qualifying rules, they would need to hold 5% or more of the company’s share capital, and 5% of the voting share capital.
In most cases, employees would only be liable to CGT at 10% — or 20% on the gains when selling their shares.
Save As You Earn (SAYE)
SAYE is a savings-related share option scheme. Over a period of either 3 or 5 years, employees pay up to £500 a month into the scheme through PAYE.
At the start of the 3- or 5-year period, employees are offered shares at a discounted purchase price of up to 20%. At the end of the period, the scheme pays them a bonus (and sometimes interest) which can be used to purchase the shares at the agreed price.
Should employees elect to purchase the shares, there are no Income Tax implications.
If they leave before the required three or five years is complete, employees will be unable to exercise the options and purchase the shares. However, they can withdraw their cash (with any bonus or interest from the scheme) and this amount is still tax free.
A potential bonus with the SAYE scheme is the ability to avoid CGT altogether. Provided employees transfer the shares into an ISA within 90 days, or directly into a pension, they will not pay any CGT.
Non-tax advantaged share option schemes
If the above-mentioned HMRC approved schemes are not available or appropriate for your business, you can still incentive employees with share options.
Under a non-tax-advantaged share option plan, employees are given the opportunity to purchase shares at a specified future date, and at a price normally set at the date of grant.
They pay Income Tax only at the point at which they exercise their options. The tax is charged on the difference between the shares’ market value at the date of exercise and the amount paid for the shares under the option.
How the tax is collected will depend on whether the shares are considered ‘readily convertible’ (easily converted to cash) — for example, if the company is listed on a stock exchange.
Should the shares be readily convertible, NIC will also be due on the value at exercise, collected through PAYE.
Under these circumstances, the company may consider offering its employees ’sell to cover’ opportunities where, at exercise, the required shares are sold to cover their Income Tax and NIC liability. This avoids generating a tax liability without the cash to fund it.
Should an employee sell their shares shortly after exercise, there may be no CGT due on disposal.
If the shares are not readily convertible, an employee may be left with shares they are unable to sell on a listed stock exchange, but with a tax liability to fund.
Given that the tax impact for the employees can be rather substantial on non-tax advantaged option schemes, it is best to take advice regarding the exposure risks.
The tax implications
A brief overview of the potential tax impact on the employees at the grant, exercise and sale of the options schemes is outlined below:
| EMI | CSOP | SAYE | Non-advantaged |
Grant | No tax implications | No tax implications | No tax implications | No tax implications |
Exercise | No Income Tax or NIC if the exercise price is equal to the full market value at grant, and exercise is within 10 years of the grant. | No Income Tax or NIC due if exercised between 3 and 10 years. | Any bonus or interest from the scheme is tax free. No Income Tax or NIC due on exercise of the options. | Income Tax (and maybe NIC) due on the difference in the exercise value and the exercise price. |
Sale | CGT is due on the increase in value between grant and sale. BADR can be available if option was granted at least two years ago. | CGT is due on the difference between proceeds and the exercise costs (and any value liable to Income Tax if relevant)
| CGT is due on the increase in value between the purchase price and sale. Options to avoid CGT by transferring directly into ISA or pension. | CGT is due on the increase in value from exercise to sale. |
Other (non) options?
Your company might not offer share options. Instead, you may want to consider an HMRC-approved Share Incentive Plan (SIP) which offers beneficial treatment on acquiring shares.
Otherwise, the simplest way to give employees a share in the business is to gift shares in the company. Consider the implications on the employees as they can be quite significant:
- Generally, they will be liable to Income Tax on the actual value of the shares they receive. This could result in a tax liability with no cash to fund it.
- Any restrictions or conditions on shares can change the treatment of the share on award, the position when restrictions lift, and future disposal.
- If the shares the employee receives are considered ’readily convertible’, NIC will also be due on the value. The Income Tax and NIC will need to be collected through PAYE.
Finally, if you do not want to offer physical shares, but still want employees to benefit from the growth in value, you can offer Phantom Share Schemes — cash bonuses linked to the value of the shares at the time. These schemes are taxed in the same way as any other cash bonus.