Enterprise Management Incentive share scheme

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.