Wider employee ownership will benefit employees, businesses and the wider economy, bringing the potential for higher productivity and profitability. It also helps businesses retain skilled people and recruit new talent.
Employee Share Ownership Schemes (ESOS) allow employees to acquire equity in the business and, typically, in a very tax-efficient manner. However small the equity, it encourages employees to think like business owners and consider long-term performance as they will share the rewards.
Employee ownership can also be an excellent choice for owners wishing to sell their business. Selling the majority of shares to an Employee Ownership Trust (EOT) ensures they sell to people they know and trust, who share their desire to succeed.
Employee Ownership Trusts (EOT)
Selling your business to a buyer you do not know, or someone you have competed against all your life, can be tough, which is why the EOT is designed to help business owners sell to their employees.
Importantly, a sale to an EOT is entirely free of Capital Gains Tax (CGT). It is a compelling choice for business owners, as it also allows them to exit on their terms and with little disruption to the business during the sale process and beyond.
Avoiding third-party negotiations can also make for a simple, more cost-effective sale. But owners must realise, as most of the funds are paid over a period of time out of the company’s profits, they may have to wait five to six years to be fully paid.
Although the EOT trust becomes the majority shareholder, it delegates business as usual activities to the directors. This ensures little change in the management structure, unless it was specified by the owner before the sale, in line with a succession strategy.
Employees of an EOT-controlled business can each receive annual bonuses up to £3,600 free of income tax, but National Insurance Contributions (NICs) will apply.
Employee Share Ownership Schemes
Various ESOS are available to business owners, each with different benefits and tax advantages that can be used to help shape the future of the business and reward some or all of the employees.
Now, we will consider the three most popular schemes. Each offers tax advantages, but before selecting the scheme that is best for their business, owners should seek further advice on the tax treatment, which can be complex and requires more explanation than is possible in this short article.
Enterprise Management Incentive (EMI): This is a discretionary share option scheme that provides a tax efficient and flexible way for smaller companies to reward some or all employees, by offering them the opportunity to buy shares in the business in the future, at a price fixed when this offer is made.
The company must be independent, have gross assets not exceeding £30m and employ fewer than 250 people. Each employee may be granted options over shares with a value of up to £250,000 at grant date, with the overall company limit set at £3m.
The EMI options can be granted over different share types, with any exercise price and any performance conditions. The options can be exercised any time after grant, but will typically lapse 10 years after grant.
Options are free of Income Tax and NICs, but gains will typically be subject to CGT, but thanks to the application of Business Assets Disposal Relief (BADR), it is usually levied at 10%.
Company Share Option Plan (CSOP): Another tax advantaged discretionary share option plan, for bigger or non-EMI qualifying businesses. It can be made available to all employees or a select few and tailored to meet business objectives with different share classes and performance targets.
The individual option limit of £60,000 is less generous than with an EMI and options must be granted at market value. Although the tax treatment is similar, participants may only exercise their options tax efficiently, three or more years after the grant date; BADR does not apply.
Share Incentive Plan (SIP): This equitable, all employee share plan provides a potential zero tax rate, with no income tax, no NICs and no CGT.
Shares can be gifted free of income tax and NICs to employees, who may also choose to buy ‘partnership’ shares out of their pre-tax salary, which may entitle them to receive a further two free ‘matching’ shares for each ‘partnership’ share they bought.
Common pitfalls
Professional advice is essential to ensure any plan from set up and throughout its life, satisfies the commercial objectives and retains its tax beneficial status. Business owners will need to identify participants, consider how much equity to use and think about how they deal with leavers.
It is critical to understand that all employee share plans must be legislatively compliant at all times and HMRC registered, with annual returns required. Failure to comply may result in fines, or in the worst-case scenario, risk losing the tax advantages.
- John Dormer has worked for over 20 years with private company owners and plc remuneration committees, supporting them in the establishment and operation of employee share plans.