Why now is the time to start a share scheme
Now, during the recession, could be the best time to establish a share scheme for your most valuable employees.
By Lesley Stalker, head of tax at Robert James Partnership
This is because all assets (including the value of your firm) lose value during a recession and although the shares you offer today as options to employees are worth less, the inevitable recovery will push value higher.
When they exercise those options, your staff could see a far greater ultimate uplift, and enjoy financial gains which are very tax efficient.
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The best way to do this is to issue shares through a tax advantaged share scheme, such as the Enterprise Management Initiative (EMI) scheme. The EMI scheme has certain eligibility criteria, one of these being that your business must have fewer than 250 employees – which is of course great for small businesses.
Why launch an employee share scheme?
Giving employees a chance to participate in the future success of your business is a very powerful motivator. In the current challenging climate, you need full commitment from your key team, yet perhaps you cannot to afford offer your best people salary increases or immediate financial incentives.
Thus share options, which can be directly linked to ensuring your staff perform well, are a useful strategy. Restricting the right to exercise shares before (say) two or three years will also help to retain the highest performing employees.
How do share schemes work?
When you launch an EMI share scheme, you are effectively giving employees – it is wise to select only those who directly contribute to business growth - the future right to buy shares in your company, at a price which is fixed today.
At the outset it is sensible to ensure that HMRC accepts your valuation of the shares over which the company is granting options.
When the economy recovers and business assets, including the shares in your company, increase in value, employees may wish to exercise their right to buy the shares at the original price and potentially sell them for a profit.
Very often, share schemes are set up to enable employees to exercise their options and sell immediately afterwards at the point of a company sale. But it is also possible to create an internal marketplace for trading your company shares and this can provide both you and the company with additional tax benefits.
Example:
You own an advertising agency and its shares have been agreed by the Shares and Assets Valuation team at HMRC to have a market value of £10 per share.
Your company launches an EMI scheme under which employees are granted an option to buy a set amount of shares for £10 per share.
Then, four years later you agree to sell the business and each share is now valued at £100.
Employees exercise their options and immediately sell their shares, making a £90 profit from each share owned.
The company receives corporation tax relief at the point of exercise, based on the difference between the market value of the shares at the date of exercise, and the exercise price paid by the employee(s).
Why is now such a good time to start a share scheme?
The primary benefit of launching a scheme now is that the potential upsides will be greater - because your current company valuation is likely to be lower than it was, for example, a year ago. Inevitably during a recession all assets lose value, even if the business is doing well.
Why is a share scheme tax efficient?
Firstly it is important to highlight that only “recognised” share schemes are tax efficient.
For such schemes, the value of the shares granted should be approved by HMRC, following which there will be no tax liability either on grant or on exercise of the options.
Capital gains tax will apply (at 18 per cent) when the shares are sold, rather than income tax (at a top rate of 40 per cent) when the share options are exercised.
To establish a recognised scheme such as an EMI, a company must meet the necessary qualifying criteria and the options and the notification of these to HMRC should meet the clearly set out procedure.
Furthermore, with an EMI you have the ability to agree the share valuation in advance of granting the options.
With unapproved share schemes however, the initial option value is not agreed by HMRC until after the grant, so this figure could be disputed in the future. This may give rise to an additional income tax liability which, from experience, is likely to be payable at the 40 per cent level.
In part II, Lesley Stalker outlines further tax advantages for business owners of creating an EMI share scheme.
www.rjp.co.uk
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