Last week, I looked at the Enterprise Management Incentives scheme, the latest Government tax incentive which is aimed at encouraging wider share ownership. Now let us consider the following example of how the EMI could work.
An employee is granted an EMI option over a total of 100,000 shares when the market value is £1 a share. The employee exercises the option two years later when the shares are worth £3 and enjoying a paper gain of £200,000. No income tax or National Insurance contributions will be payable on this paper gain of £200,000.
The employee decides to sell the shares two years later when they are worth £500,000. With four years' taper relief, the gain of £400,000 will be reduced to £100,000. In effect, the full gain will be chargeable at an effective capital gains tax rate of only 10 per cent for a higher-rate taxpayer, giving a tax bill of around £40,000.
Increasingly, those advising on employee benefits cannot afford to be unfamiliar with any of the methods of remuneration in the UK. This is especially so for remuneration methods that offer particular tax incentives such as the new share and EMI schemes, particularly in the light of the further relaxations introduced by this year's Finance Act. It will be rare that an employer does not at least wish to consider these schemes.
It is essential to remember that with the EMI scheme there will be no income tax or National Insurance implications on the grant of the options or, normally, on exercise of the options, and capital gains tax will be deferred until the gain is realised on disposal of the shares acquired under the option.
Also of importance is the fact that the qualifying period for business assets taper relief will start running on the day the option (and not the shares) is acquired, that is, from the date of grant of the option. Thus, even when the shares are realised, the maximum effective rate of tax (assuming the four-year qualifying period for business assets taper relief is satisfied) for a higher-rate taxpayer would be 10 per cent for qualifying shares.
This is extremely attractive but it is worth remembering that for many employees of small private companies, despite the tax attraction of the scheme, the benefit may not be seen as terribly attractive.
Unless there is an obvious market or potential market in the shares, for example, a planned flotation or buy-back scheme, then realising any value from the share scheme will be very difficult and the incentivising effect of the shares will be reduced substantially.
This is also true of any shares that may be acquired under the all-employee share option plan that can even provide for free shares to be granted to employees.
As always, the adviser will need to be aware of the requirements and aspirations of his client – who could be either an employer or an employee or both – and the possibilities emerging from and the tax treatment of the share schemes available.
For many small private companies without flotation aspirations and with no buyback plans, a more traditional mix of pensions and investment-based schemes may offer employers and employees the most attractive combination of enhancing employee loyalty and incentivisation (for the employer) and financial benefit (for the employee).