Alternative employee share options are possible if EMI is not an option. These include: unapproved options, share awards and flowering shares.
EMI options are the most tax efficient and flexible type of arrangement available and will always be the currency of choice for a diverse range of business sectors and sizes. Particular interest though may be by those with overseas activities or high tech companies.
There are, however, various conditions which have to be met by the company and the employee for them to be eligible for the favourable tax treatment EMI options offer. For example, the company must be an independent trading company or the holding company of a trading group not carrying on certain activities. At the time of grant, the company have gross assets of less than £30 million and have less than 250 employees in the group.
An employee (i.e. not a consultant or non-executive director) is only eligible for EMI options if he works for an average of at least 25 hours a week or, if less, 75% of his working time; and, at the time of grant, he does not have a material interest in the company or any other group company. A material interest means owning or controlling more than 30% of the ordinary share capital.
It may be worth reviewing whether there are any ways of bringing the parties within the EMI framework. If it is not possible or not desired then there are other choices available for private companies and quoted companies as set out below.
Generally speaking unapproved options are not tax efficient compared with other types of equity arrangements. In a nutshell, if the unapproved options were exit only – i.e. exercised on the sale of the business or on a merger (as is the case with many unapproved options) – the combined rate of income tax and national insurance payable on the gain made on exercise can be well over 52% calculated at top rates of current tax. The gain for income tax and national insurance purposes is the difference between the price paid to acquire the shares less the value of shares at the time of exercise.
The advantage of a share award is that the award can be structured so that any growth in value (i.e. the difference between the amount the employee pays to acquire the shares and the exit value) falls to be treated as capital rather than income. Rates of capital gains tax range from 20% to 10% depending on earnings and 10% if entrepreneurs’ relief is available.
The basic rule is that if an employee (or an employed director) is given shares at an undervalue or a discount HMRC will seek to charge income tax. Providing there is no market for the shares such as an employee benefit trust or a trade sale or a listing there will be no employer’s or employee’s national insurance to pay and the amount charged to tax will be the difference between the amount paid by the employee to acquire the shares and the “tax market value”. The tax market value in cases where this is likely to be less than any established value has to be negotiated with HMRC.
The broad idea behind flowering shares is that when the shares are awarded they have a low value usually because they are subject to milestones or are over a small percentage of the equity. When triggers or targets are met the shares become more valuable – i.e. flower. The tax market value of such shares is reduced to take account of the restrictions on the shares – the reduction depends upon the facts. However, if the employee pays the tax on receipt of the shares any growth in value as the shares “flower” should be subject to capital gains tax. Flowering shares are a different class of share to those held by ordinary shareholders. Issues such as voting rights, forfeiture, dividends and assets on a distribution all add to the mix and vary depending upon requirements.
For more information on share awards, please visit our share award page.
Helen Curtis is a member of the employee share plan team. There are many surveys and statistics which show that companies with employee share plans in place out perform those without. We implement a wide range of solutions for a wide range of business needs.