How to balance the books? - Share Schemes from the Finance Director's perspective
In current economic times the Finance Director faces a real conundrum. How does he or she control their staff costs whilst keeping the level of productivity required for business continuity?
With margins under severe pressure it often means that there is less money in the pot to pay for staff wages. Higher rates of income tax at 40% (45% from 2013/14) or perhaps 50% with Employer's National Insurance Contributions (NICs) at 13.8% and marginal Employee's National Insurance at 2% means that the cost of employment is high. So the key question is how to keep the employee wage burden down whilst retaining productivity?
Naturally there are a number of ways to do this but one mechanism is to use an equity based reward plan such as the highly tax efficient Enterprise Management Incentive (EMI) to compensate for static or low pay rises and/or lower bonus awards. Whilst initially this may be a difficult message for the employee to swallow, once the benefits of an equity based reward plan are explained the scepticism tends to rapidly dissipate.
There are four key advantages to the EMI share option plan:
- The concept of fair value from HMRC means that provided share options are granted at or above fair value there is no tax to pay on the grant of the option. If the shares were simply gifted to the employees then the gift would be taxable as income (under the employment-related securities legislation) with the consequences as noted above.
- Often, for private companies, the fair value negotiated with HMRC for these purposes represents a 60-70% discount to the true commercial value. For a business with an overall entity value of 1p per share this means that share options could be granted with a market value exercise price of around 30p. Hence there is immediate lock-in (or potential paper gain) for the employee given the inherent value in the share price.
- Any gains made on those shares would be subject to the capital gains tax regime under which personal allowances are available (£10,600 per annum [2012/13], and £10,900 [2013/14]) and taxed at a top tax rate of 28% which makes the net cash position versus salary and bonus more attractive for the employee.
- There is a very valuable corporation tax relief available at the point of exercise of the share option. The relief is calculated based on the difference between the share price at which options were granted and the share price of the company at the point of exercise. For high growth companies this can produce some significant corporation tax savings and the relief operates to provide a tax deduction for the dilution cost.
One key benefit of the EMI is that employees become more engaged with the company as they will potentially own some of the share capital, which empirical evidence (including research by Cass Business School) shows helps to improve performance and productivity. The shares used for the EMI may or may not carry voting and dividend rights (at the shareholders discretion on scheme design) and could potentially be sold by employees into an internal market such as an Employee Benefit Trust. Thus the employee may have a line of sight to a high value capital sum as a future reward and is incentivised to be more productive and grow shareholder value.
The result? Well if employees are appropriately educated about equity based incentives and existing shareholders design, implement and administer the plans effectively then the net result for the company is lower wages, higher productivity and more profit. Everyone is a winner!
If you would like to discuss the EMI scheme in more detail then please call the office on 020 8949 5522 and speak to any one of our advisers.