Last week, when I started to look at unapproved share option schemes, I noted that their key tax disadvantage is that an income tax charge can arise when the option is exercised based on the difference between the market value of the shares when the option is exercised and the option price.
Of course, an income tax charge means no use is made of the annual capital gains tax exemption and, perhaps more significant, there is no use of taper relief at either the business assets rate or the ordinary investment rate.
This week, I would like to stay with share option schemes but to take a look at approved schemes, the most recent addition being the Enterprise Management Incentives scheme which came into being last July.
Let us first consider the savings-related or SAYE share option scheme. To be approved, it must be open to all employees who are taxed under Schedule E Case 1. However, the company can restrict eligibility to those who have been employed for a minimum period of up to five years.
The terms on which the options are granted must be similar for all participating employees. However, terms may vary by reference to service and pay, which actually leaves quite a bit of scope for variation among employees.
The most attractive tax aspect to the SAYE scheme is that, provided it is approved, there is no income tax to pay when the option is granted, when it is exercised or under the provisions of s162 (acquisition of shares by an employee at an undervalue by reason of his employment).
As a condition of approval, the option price must not be less than 80 per cent of the market value of the shares concerned at the date the option is granted.
Another key condition concerns when the option can actually be exercised. When an employee enters into a scheme, he or she must decide when the bonus date should be. This fixes the exercise date. Subject to some exceptions, this can be three, five or seven years after the commencement of the savings contract underlying the SAYE part of the scheme. As stated above, at this point, even if the market value of the shares in question exceeds the option price – as the employees would obviously hope it would – then no income tax or capital gains tax will be due on this difference.
As the title of the scheme implies, the SAYE share option scheme is a combination of the issue of share options and a savings scheme to provide the means of exercising the option. As such, the scheme combines the opportunity to profit from the increase in the share price of the employer with an easy-to-understand, risk-free and tax-efficient savings vehicle.
The SAYE part of the scheme is provided through an SAYE contract entered into with a building society, authorised bank or another authorised financial institution. The scheme, especially by virtue of being an all-employee share option scheme, is aimed at the relatively low end of the market.
Employees can save a minimum of £5 and a maximum of £250 a month with the institution offering the SAYE contract. The sums saved are held on deposit. No tax relief is given on the amounts invested but the interest generated is accumulated tax-free.
As well as interest, SAYE schemes also offer bonuses after three, five or seven years as appropriate. These are also tax-free. The SAYE scheme thus represents a kind of forerunner to the cash Isa. Even the upper limit of £3,000 a year is the same. Under the SAYE scheme, the funds are usually used to exercise the option but there is no compulsion to use the funds to make a share purchase.
It will be interesting to see whether these schemes lose popularity with the advent of the new all-employee share scheme providing for the tax-efficient issue of free shares by the employer. The acquisition of partnership shares by employees and also further matching shares from the employer means that up to £7,500 of shares could be acquired each year for each employee. I will look at this in more detail in later articles.
There is, however, nothing to prevent an employee participating in both schemes although, in practice, it is unlikely that an employer would want to run both.
Regardless of this, it remains my view that, even if a financial adviser does not implement these schemes, they should at least know about them.