Enterprise Management Incentive share scheme

Posted by RM2 at 10:40 on 12 Oct 2016

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The need for guiding principles

It’s easy to get lost in the complexity of regulations and

tax rules around employee share schemes. There are no clearly, readily

understandable principles or policy objectives defined in the regulations

themselves. Instead, the regulations and tax rules are the result of an

ever-shifting bargain between special interest groups, for example, employees,

business managers, investors and the government. A further result is a

proliferation without any limit (other than the creativity of advisors) in the

types of employee share scheme available. Each has slightly different

objectives, is designed with different regulations in mind and with an alphabet

soup of names: CSOP, EMI, SAYE, SIP, DSPP, USOP (and so on…).

If you are a business owner or manager thinking about

implementing a share scheme, are there any guiding principles? I suggest that,

yes there are, although you will need to accept that there will always be some

approximation, grey areas and borderline cases!

A suggestion for guiding principles

Current capital value, capital growth and income. These are

the three economic concepts which I think can be helpful to categorise and

provide a starting point to explore the possibilities of employee share

schemes.

It’s often argued that they are different sides of the same

coin – but this is not true when it comes to the most important question in

employee share schemes: how will the share scheme put cash in an employee’s

pocket? Realising cash in each context requires different legal steps and which

will have different tax implications.

Current capital value and capital growth: the sum of this

represents what a third party would be willing to pay for the whole company. It

doesn’t necessarily follow that a share or option will represent a simple

percentage of that. A floor may be added to a share or option (often referred

to as a hurdle for a share, or the exercise price for an option) so that on a

sale, the employee only receives cash to the extent that the value of the

company has grown.

Income: this represents the profit earned by a company, to

the extent that it is distributed as a dividend. A sale isn’t necessary for the

employee to receive cash from a dividend. However, the existing tax rules

normally require that a share has been paid for or taxed before an employee may

receive income from it.

Why is this useful?

Government policy, and therefore tax relief attaching to

different schemes, favour capital growth first and existing value second. A

decision on whether to reward employees by reference to current capital value,

growth in value or income can inform the choice as to which share scheme is

appropriate.

If you wish to reward employees by reference to only capital

growth, there are plenty of schemes to choose from which attract favourable tax

treatment: an EMI, CSOP, SIP, GSP, JSOP ESS or DSPP could all be considered.

If you wanted to reward employees by both capital growth and

existing value, the list is shorter: it is not possible under a CSOP, there is

no tax relief for existing value under an EMI, but there is potentially

favourable tax treatment for both elements under a SIP, SAYE, ESS or DSPP.

The thoughts above assume that there is an expectation of a

sale (how else is an employee going to get cash?). If this is not the case,

rewards by reference to current capital value or growth in value is still

possible, but requires more detailed planning.

Rewarding employees by reference to income also requires

more detailed planning, and arrangements may need to be put in place to fund an

upfront purchase price or tax. An EMI, SIP, ESS, EOT or DSPP could be

considered.

I’m thinking of implementing a share scheme

Making the decision on whether to reward employees by reference to current capital value, growth in value or income is a useful first step. If you would like to discuss which share scheme might be appropriate with one of RM2’s specialists, please contact us.