John Dormer, Share Incentives Director at The RM2 Partnership, discusses employee ownership.

 

Employees, businesses and the wider economy can benefit from employee ownership, as it promises to improve staff retention and recruitment whilst boosting productivity and profitability. By allowing employees to acquire equity through tax efficient means, Employee Share Ownership Plans (ESOPs) promote positive employee behaviour by encouraging them to think more like business owners, with the incentive of future rewards.

For those owners looking to sell their businesses, employee ownership can be a very effective option. By selling the majority of shares to an Employee Ownership Trust (EOT), owners can be confident the business will go to like-minded individuals they have previously worked with and therefore trust.

Employee Ownership Trusts (EOT)

The idea of selling a business to an unknown buyer or competitor can be off-putting for owners, which is why many use EOTs to ensure dedicated employees reap long-term benefits. Free of Capital Gains Tax (CGT), a sale to an EOT is a compelling prospect for owners, as it gives them increased flexibility to decide their own exit terms without disrupting the business’s ongoing operations.

The removal of third-party interference and negotiations can make the sales process more efficient too, although it’s important to note that funds are paid out over a period of time from the company’s profits, and in some cases, the full amount can take five to six years to be paid.

Whilst the EOT trust becomes the majority shareholder, general business activities are delegated to the directors as a way of ensuring limited change to the management structure, unless previously outlined. Employees of an EOT-controlled business can each receive annual bonuses up to £3,600 free of Income Tax, but National Insurance Contributions (NICs) will apply.

Employee Share Ownership Plans

There are various Employee Share Ownership Plans available to business owners, each with its own set of benefits and tax advantages that can help shape the future of the business and its employees. Most owners choose between three popular plans, but before making a final decision, they should seek further advice on the tax treatment of each. The three options include:

• Enterprise Management Incentive (EMI)

This is a discretionary share option plan that provides a tax efficient and flexible way for smaller companies to reward some or all employees by offering them the opportunity to buy shares in the business in the future at a price fixed when this offer is made.

The company must be independent, have gross assets not exceeding £30m, and employ fewer than 250 people. Each employee may be granted options over shares with a value of up to £250,000 at grant date, with the overall company limit set at £3m.

The EMI options can be granted over different share types, with any exercise price and any performance conditions. The options can be exercised any time after grant but will typically lapse 10 years after grant. Options are free of Income Tax and NICs, but gains will typically be subject to Capital Gains Tax (CGT), but thanks to the application of Business Assets Disposal Relief (BADR), it is usually levied at 10%.

• Company Share Option Plan (CSOP)

Another tax advantaged discretionary share option plan for bigger or non-EMI qualifying businesses. It can be made available to all employees or a select few and tailored to meet business objectives through different share classes and performance targets.

The individual option limit of £60,000 is less generous than with an EMI and options must be granted at market value. Although the tax treatment is similar, participants may only exercise their options tax efficiently three or more years after the grant date – BADR does not apply.

• Share Incentive Plan (SIP)

This equitable, all employee share plan provides a potential zero tax rate with no Income Tax, no NICs and no CGT. Shares can be gifted free of Income Tax and NICs to employees who may also choose to buy ‘partnership’ shares out of their pre-tax salary, which may entitle them to receive a further two free ‘matching’ shares for each ‘partnership’ share they bought.

Always seek specialist advice

To ensure the plan is correct and it matches your personal and business expectations, it is important to seek advice from a specialist before making a final decision. This will help you identify participants, consider how much equity to use, and understand how you have to deal with those with share options who then leave the business.

It is critical to understand that all employee share plans must be legislatively compliant at all times and HMRC registration, including filing annual returns, is required. Failure to comply with any of the regulations may result in fines, or in the worst-case scenario, risk losing the tax advantages of the plan.

For further information on The RM2 Partnership, please click here.