Equity based staff rewards for tough times
Employee share schemes are already commonplace in UK quoted companies. These often take the form of share options or awards of shares which are released to employees over time on the achievement of performance targets. Now, however, smaller companies are using specially designed schemes, such as the government sponsored Enterprise Management Incentive (EMI), to help them get through tough times. These schemes not only provide effective incentives for staff members but also offer the potential to save large amounts of tax and conserve cash.
Benefits of equity based staff rewards
For most Intellect member companies, their core asset is their staff. It is vital to attract, motivate and retain the best people. This is especially challenging for smaller companies because they may not be able to match the fringe benefits and brand profile offered by larger organisations. Many companies have responded by locking in their best people with equity based incentives that align the interests of key staff members with the majority shareholders.
But there are other considerations. In today's tough trading environment, it may be difficult or impossible to mobilise the cash for bonuses or in some case, even to pay the basic salaries. Equity based schemes can offer a lifeline. They represent demonstrable value for the participant and the potential for significant gains as the company pulls through and equity values increase.
For rewards at the higher end of the scale, the new tax rules from April 2010 will be a significant problem. Cash benefits above £150,000 will bear a 50% rate of tax. The total tax take, include employer and employee NI will rise to a confiscatory 64.8% almost two thirds. What is less well known is that, because of claw back of personal allowances, there will be a special marginal tax rate of 60% on income between £100,000 and £112,950 with NICs to pay on top. And the NICs themselves increase further in 2011.
Gains on employee share schemes, by contrast, are taxed at lower rates, and in some cases not at all. How do these benefit work?
A very popular employee share scheme for smaller companies is the government sponsored Enterprise Management Incentive. If the option is granted with an exercise price at fair market value, subsequent gains are taxed at capital gains tax rates only, currently 18%. EMIs are discretionary, that is, the company can pick and choose which employees will benefit. Other plans are available which can offer tax efficient solutions for the entire workforce. Under a Share Incentive Plan, which is also government sponsored, share are placed in trust for employees, usually for a minimum period of three years. After this period the shares can be withdrawn, and any gains are tax free. But if the shares are left in trust for five years they are completely free of income tax, capital gains tax or indeed any other tax. There are other government schemes available as well, each of which offer their own advantages.
Inevitably, with tax advantages like these, the government puts limits on the values of shares that can be gifted, or offered under option. However there are alternatives. These include schemes such as the Deferred Share Purchase Plan (DSPP) and the Joint Share Ownership Plan (JSOP). They are not government sponsored and therefore not subject to limits. However they are still tax efficient: the participant pays only capital gains tax on the gains. Unlike the approved plans, there are risks to the participant if the employing company fails, but these can be minimized.
To realise their benefits, scheme participants must sell their shares. In a private company there is no market for them. However many smaller companies have an exit plan, such as a trade sale or flotation, which will provide staff members with an opportunity to cash in. Other companies create a virtual internal market using an employee benefit trust. This uses company money to repurchase shares from scheme participants and then offer them out again for new tax-efficient incentives.
In summary, employee share schemes are not just about attracting and retaining good people. They can generate large tax savings and also conserve cash. They can be used by smaller private companies as well as larger quoted concerns. For these reasons, smaller companies are increasingly turning to employee share schemes as a weapon of choice for surviving the current hostile commercial and fiscal environment.
The RM2 Partnership specialise in the design and administration of employee share schemes. For further information, you can speak to Colin Paterson personally on 020 8949 5522 or continue exploring our website!