Unlisted companies - awarding shares to employees
Incentivising employees with awards of share offers a number of advantages. Unlike options, employees become shareholders from the outset and part owners of the business. If the company is profitable, employees may be eligible for dividends on their shares. The recent Budget announcement that the first £5,000 of dividends will be tax free from 6 April 2016 will be a significant boost to employee share ownership, while offering a tax efficient means of distributing profits without National Insurance (NI) costs. Companies should not overlook the new opportunities that flow from extending employee share ownership as a result of the changes to the taxation of dividends.
It would be appropriate to consider first if the company can make awards of shares under a tax advantaged share or option plan. The Share Incentive Plan (SIP) is the only tax advantaged plan that offers awards of shares. It might be the case that the cost of a SIP and its operation is not warranted owing to a small number of employees and the size of the company.
Another alternative would be the grant of Enterprise Management Incentive (EMI) options. These are usually straightforward to establish and options might be granted on terms they are immediately exercisable, if it is intended employees will become shareholders at grant. An advantage of EMI is that a share valuation can be agreed with HM Revenue & Customs (HMRC) in advance of the grant of options. This means that company and employee will have certainty as to the amount chargeable to income tax if the exercise price is set at less than the tax values agreed with HMRC.
If the tax values of share are high, EMI might not be appropriate if the employees are going to have to fund the full purchase price, or income tax if options are granted at a discount to the tax values. EMI does not offer the ability to receive partly paid shares on option exercise. Shares must be fully paid on exercise to qualify for EMI.
A further alternative would be to award partly paid shares (deferred payment shares). This would overcome the need to fund the acquisition immediately without crystallising an income tax liability on the full value of the shares. Shares could be awarded over a new class that might not be voting, but could be eligible for dividends. Employees would have to pay at least the nominal or par value on award (this could be kept low if a new share class is used). There would be an annual benefit charge (P11D) on the amount of the unpaid balance of the shares and employer’s only NI. In this way employees could become shareholders from the outset and might be able to fund much of unpaid balance from dividends.
On sale of the shares, provided the unpaid balance of the shares has been paid in full, the employee should pay capital gains tax (CGT) on the excess of the sale price over the purchase price. Entrepreneurs’ Relief (ER) at 10% on chargeable gains will be available if the employee has acquired 5% of the ordinary shares and has held the shares for at least a year before sale.
Partly paid shares may not be appropriate in cases where EMI offers greater flexibility; and where there is no desire for employees to become shareholders before a milestone event or performance achievement. Partly paid shares are not risk free arrangements in that the obligation will not fall away if the company were to become insolvent.
In summary, there is no ‘one size fits all’ approach and companies should review the alternatives carefully as to how best to implement shares incentives.