This note has been updated to reflect changes to EMIs and SIPs that came into force on 6 April 2013.
This note provides an overview of the various employee share option schemes and share incentive plans available to companies and a description of the tax treatment of each.
This overview note is available to all PLC subscribers but contains links to more detailed PLC Share Schemes & Incentives content.
Almost all UK-listed companies offer some form of equity (share) incentives to their executive directors and employees (see Quick guide: Share scheme issues for listed companies (www.practicallaw.com/7-381-9419). Share plans are also feasible and attractive for many private companies, although sometimes care needs to be taken with tax and other issues (see Quick guide: Share scheme issues for private companies (www.practicallaw.com/9-380-0683)).
This note gives an overview of some of the common types of employee share incentive arrangements used by UK listed and private companies, and also briefly outlines the regulatory, tax and other issues that companies and their advisers need to consider when designing, adopting and launching a share plan.
The government has published draft legislation to be included in Finance Bill 2013 that will in some cases significantly change the rules for operating tax-advantaged share schemes. The legislation for these arrangements will be simplified, with major changes to the provisions relating to tax-advantaged exercise after leaving, retirement ages, use of restricted securities and material interests. These changes will come into force during 2013, most taking effect when Finance Bill 2013 receives Royal Assent. For more information, see Legal update, Draft Finance Bill 2013: Tax-advantaged share scheme simplification (www.practicallaw.com/0-523-0840).
This note reflects the current rules applicable to tax-advantaged share schemes. It will be updated in 2013 to reflect the changes as they come into force.
The main reason for using employee share incentive plans is to recruit, retain and motivate employees. They are also used to help align the interests of employees, particularly senior executives, with those of shareholders. The aim of this alignment is to encourage senior executives to consider the best interests of shareholders in their management of the business. This can be particularly important in listed companies (www.practicallaw.com/6-203-2398).
Employee share incentive plans can also reduce employment costs. Successive governments have taken the view that encouraging equity incentives can improve the general economy. Tax legislation has therefore been used to introduce specific employee share scheme structures that enjoy valuable tax reliefs.
Some employee share schemes benefit from favourable tax treatment, provided certain statutory rules are complied with (tax-favoured or tax-advantaged schemes). Tax-favoured arrangements can be divided by the employees that can participate. Some types of tax-favoured schemes have to be made available to all qualifying employees (all-employee schemes), whilst under others, the board of directors can select the employees to be be invited to participate (discretionary schemes).
Tax-favoured schemes are generally subject to prior approval by HM Revenue & Customs (HMRC) (HMRC-approved schemes), with the exception of EMI options, which are not pre-approved, but must be notified to HMRC after grant in order to qualify.
For a quick comparison of the relative advantages of the different tax-favoured schemes, see Practice note, CSOPs, SIPS, SAYE and EMI options: a comparison (www.practicallaw.com/2-205-7140).
There is also a range of other share incentive arrangements that do not attract any tax advantages (non-tax favoured, unapproved or fully taxable schemes), but that companies find useful for their flexibility. Whilst a company could adopt an unapproved all-employee plan, generally fully taxable plans are discretionary.
CSOPs (www.practicallaw.com/1-107-5956) enable companies to grant share options (www.practicallaw.com/0-107-6937) to their employees. If statutory conditions are met, a CSOP can be approved by HMRC and favourable tax treatment can result.
As with any share option, a CSOP option is risk-free for the employee, in that there is no initial financial commitment or future obligation to exercise the option.
There are complex statutory provisions governing which companies are permitted to adopt an HMRC-approved CSOP and the shares that can be used. If the plan does not come within these rules, the plan will be an unapproved share option scheme.
In summary:
The company whose shares are placed under option must be either listed on a recognised stock exchange (www.practicallaw.com/2-200-8362) or free from the control of another company.
The options can be granted either by the employer or a parent company (www.practicallaw.com/4-107-6964) (but CSOP options cannot be granted over shares in an unlisted subsidiary of a listed company).
The shares under option must be ordinary shares (www.practicallaw.com/2-107-6941) that are not subject to any special restrictions.
These rules are not normally a problem for companies listed on the London Stock Exchange (www.practicallaw.com/2-107-6795) (or any other recognised stock exchange). They are also unlikely to cause a problem for companies whose shares are traded on AIM (www.practicallaw.com/8-107-6392) (which is not a recognised stock exchange).
However, private companies or overseas companies with UK employees wishing to adopt a CSOP will have to review these rules carefully. For more information on issues for private companies, see Practice note, Private companies and share plans: Specific difficulties with approved schemes for some private companies (www.practicallaw.com/9-375-9283).
Under an HMRC-approved CSOP, the company has discretion over which employees can participate.
However, CSOP options can only be granted to employees and full-time directors. HMRC interpret "full-time" as meaning at least 25 hours per week, excluding meal breaks. Non-executive directors (www.practicallaw.com/1-107-6531) (unless they are "full-time", which would be very unusual) and consultants (www.practicallaw.com/6-200-3107) cannot participate. For more information, see Practice note, Who can join a share scheme? (www.practicallaw.com/3-205-8988).
Employees cannot participate in a CSOP if they (or their "associates") have a "material interest" in the company whose shares are used for the scheme, or in certain related companies (see Practice note, Material interest rules for tax-favoured share incentives (www.practicallaw.com/2-338-4952)).
The price payable for shares on the exercise of a CSOP option must not be less than their market value at the time of grant.
The market value has to be agreed in advance with HMRC if the shares fall into any of these categories:
They are unlisted.
They are traded on AIM.
They are listed, but not on a recognised stock exchange.
For more information on share valuation issues for share schemes, see Practice note, Valuing employee shares (www.practicallaw.com/8-371-6958).
The maximum value of shares (valued at the date of grant of each option) that any one person can hold under unexercised CSOP options is £30,000.
Generally, a CSOP can specify that exercise can take place at any time. The only statutory requirement regarding the time of exercise is that options must not be capable of exercise more than 12 months after the death of the option holder. However, in order to obtain beneficial tax treatment for the option holder, options must generally not be exercised before the third anniversary of grant (except on leaving for a "good leaver" reason), and so it has become standard market practice for this to be the normal earliest exercise date.
Because of the favourable tax treatment, CSOP options are generally only exercisable before the third anniversary of grant by "good" leavers (for example, death, injury, disability, redundancy or retirement). CSOP options are often also exercisable early on a corporate event such as a takeover (although this will generally not qualify for beneficial tax treatment). For more on the tax treatment of CSOPs, see Tax treatment for the employee: On exercise.
The rules of the CSOP should specify exactly when options will lapse, particularly at the end of a window period for exercise. Generally, the rules will provide that options lapse on leaving employment, although early exercise may be permitted:
In certain defined "good leaver" circumstances.
In the event of a takeover, reconstruction or winding up of the company.
Options will generally also lapse if the option holder becomes bankrupt, tries to assign the options or use them as security.
A corporation tax (www.practicallaw.com/1-107-5999) deduction may be available when CSOPs are exercised (under Part 12 of the Corporation Tax Act 2009). Relief is given in the accounting year in which the options are exercised and should be claimed by the option holder's employer company (not the company whose shares are acquired, if different).
There are some general requirements for obtaining relief that apply to both the company and employee. The most significant of these is that shares acquired must be one of the following:
Listed on a recognised stock exchange.
In a company that is not under the control of another company.
In a company that is under the control of a company whose shares are traded on a recognised stock exchange (other than a close company (www.practicallaw.com/4-107-5926) or a company that, if resident in the UK, would be a close company).
This is matches with the conditions that must be met for shares that can be used under a CSOP. However, issues can arise on a change of control where the acquiring company is AIM listed or is a private company (see Practice note, Corporation tax relief for share schemes: loss of relief on takeover by unlisted company (www.practicallaw.com/6-379-0459)).
The tax treatment for an employee holding a CSOP option is as follows:
There is no income tax liability on the grant of the option.
There is no income tax liability on exercise (assuming that the CSOP still retains its HMRC-approved status) if the date of exercise is at least three years from the date of grant.
There is no income tax liability on exercise within three years of the date of grant if the right to exercise arises because of the option holder ceasing employment due to disability, injury, redundancy or retirement and the option is exercised within six months of leaving. If there is a liability to income tax, the option holder will be chargeable to income tax on the difference between the market value of the shares acquired and the option price paid for them.
On a sale of the option shares, capital gains tax (CGT) may be payable on any gain over the amount paid for the shares (or any gain over the value of the shares at the date of exercise where an income tax charge on exercise applies).
Entrepreneurs' relief (www.practicallaw.com/4-383-5915) may be available for employees disposing of shares who own at least five percent of the company's ordinary share capital (and are able to exercise at least five percent of the votes). An employee must have held the shares for at least one year. The effective rate of capital gains tax will be 10% on the first £10 million of gains of this type that an employee makes in a lifetime. For more information, see PLC Tax, Practice note, Entrepreneurs' relief: an overview (www.practicallaw.com/2-382-4258).
If income tax is due, it will need to be withheld by the employer under PAYE (www.practicallaw.com/4-200-3405) and class 1 employee and employer National insurance contributions (www.practicallaw.com/8-201-8297) (NICs) will also be due, if the shares are readily convertible assets (www.practicallaw.com/5-107-7109) (RCAs) at the time of exercise. If they are not, only income tax under self-assessment applies. (See also Operating PAYE.)
Broadly, the NICs treatment of CSOP options follows the income tax treatment:
There will be no NICs if no income tax is due.
Class 1 NICs will be due if income tax is payable and the shares are RCAs.
The employer and the employee may enter into arrangements under which the employer NICs liability is transferred to the employee (see Practice note, Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Transfer of employer NICs (www.practicallaw.com/9-204-9057)).
For links to practice notes, standard documents and updates on CSOPs, see Practice note, CSOPs (Company Share Option Plans): guide to CSOP content and resources on PLC Share Schemes & Incentives (www.practicallaw.com/6-379-0360).
For a list of all Ask the team resources relevant to CSOPs, see PLC Share Schemes & Incentives Ask the team archive: CSOPs (www.practicallaw.com/3-301-2980).
An SAYE option scheme (www.practicallaw.com/4-107-7195) has two elements:
A savings arrangement.
A share option.
The employee can choose whether to use the proceeds of the savings arrangement to fund the exercise price of the option (although he cannot exercise the option using his own funds). If statutory conditions are met, an SAYE option scheme can be approved by HMRC and favourable tax treatment can result.
The grant of the option is conditional on the employee entering into an HMRC-approved savings arrangement. This will require the employee to save between £5 and £250 per month for three or five years generally by deduction from pay (after tax). (Compare this with partnership shares under a SIP that are purchased with pre-tax income.)
A number of the large banks and financial institutions have specialist teams that set up and operate these savings arrangements on behalf of employers.
At the end of the savings period, the accumulated savings can be withdrawn (together with a tax-free bonus equal to a guaranteed number of monthly contributions, if applicable).
In addition, an employee who chooses to enter into a five-year savings arrangement can elect to leave the account open for a further two years during which no further contributions are paid (so this is described as a seven-year arrangement). At the end of the two years a greater tax-free bonus may be payable.
The current SAYE scheme bonus rates that apply to SAYE savings arrangements, and the rate-setting methodology, are set out in Practice note, SAYE option scheme bonus rates (www.practicallaw.com/6-200-8647). Employees who sign up to an SAYE scheme will receive the bonus rate for the relevant savings period in force at the time they apply. Existing savings contracts are not affected by bonus rate changes during the savings term.
The maximum values of savings under the different types of savings arrangements can be found in Practice note, SAYE options: maximum savings, exercise price and share value (www.practicallaw.com/9-381-2681).
When employees agree to enter into a savings arrangement, they are granted SAYE options to acquire shares. The number of shares is calculated by reference to the expected proceeds of the savings arrangement (normally including any bonus) at the end of the three, five or seven year savings period chosen at the outset.
If the employee chooses at any time not to exercise the option, savings will be paid back to the employee along with any bonus or interest payable. A savings-related share option scheme is therefore risk-free for the employee until shares are acquired.
As with CSOPs, there are complex statutory provisions governing which companies are permitted to adopt an HMRC-approved SAYE option scheme, and the shares that can be used.
As with CSOPs, the shares under option must be ordinary shares. The company granting the options must be either listed on a recognised stock exchange or free from the control of another company unless that other company is listed on a recognised stock exchange. Options can be granted either by the employer or a parent company.
The SAYE option scheme must be approved by HMRC before any SAYE savings invitations are issued or options granted.
SAYE schemes are all-employee schemes, meaning that all eligible UK-resident and ordinarily resident employees and full-time directors must be invited to participate in an offer made under an SAYE scheme. A qualifying period of service may be imposed, but this cannot be more than five years (see Practice note, Age discrimination and employee share schemes (www.practicallaw.com/8-203-8766)).
Invitations to join a scheme are often made on an annual basis, although this is not a legislative requirement. The rules of an SAYE option scheme may be drafted to allow the following additional employees to take part in the scheme:
Resident but not-ordinarily resident (R/NOR) and non-resident employees and full-time directors.
Employees and full-time directors with a qualifying period of service that is less than the period specified in the scheme.
For more information, see Practice note, Who can join a share scheme? (www.practicallaw.com/3-205-8988).
Employees cannot participate in an SAYE scheme if they (or their "associates") have a "material interest" in the company whose shares are used for the scheme or in certain related companies (see Practice note, Material interest rules for tax-favoured share incentives (www.practicallaw.com/2-338-4952)).
The exercise price must be fixed when the option is granted and may not be less than 80% of the market value of the shares at or shortly before the date of invitation to participate.
As with HMRC-approved CSOPs, if the shares are not quoted on a recognised stock exchange, the market value of the shares must be agreed in advance with HMRC. The option price may be adjusted if there are certain variations to the company's share capital.
The maximum exercise price and value of shares under option (at grant) for different savings periods can be found in Practice note, SAYE options: maximum savings, exercise price and share value (www.practicallaw.com/9-381-2681).
An SAYE option cannot normally be exercised before the relevant savings arrangement matures. After the maturity date, te employee has six months to decide whether or not to exercise the option.
The attraction of an SAYE scheme is that the participant can, but is not required to, use the accumulated savings (and any tax-free bonus) to fund the exercise of the option. Alternatively, the employee can simply elect to have the savings and any bonus paid out in cash.
The rules of the SAYE scheme should specify exactly when options will lapse, particularly at the end of a window period for exercise. Generally, the rules will provide that options lapse:
On leaving employment, although early exercise may be permitted:
in certain defined "good leaver" circumstances (similar to those for CSOP options - see When can a CSOP option be exercised?); or
in the event of a takeover, reconstruction or winding up of the company.
If the employee, before becoming entitled to exercise the option, withdraws the savings or misses more than six monthly savings payments.
If an SAYE option lapses, the employee can simply withdraw the savings.
An option will also generally lapse if the option holder becomes bankrupt, attempts to assign the option, or use it as security.
A corporation tax deduction may be available for when SAYE options are exercised (under Part 12 of the Corporation Tax Act 2009). Relief is given in the accounting year in which the options are exercised. Tax relief should be claimed by the option holder's employer company and not the company whose shares are acquired, if different.
There are some general requirements for obtaining relief that apply to both the company and employee. The most significant of these is that shares acquired must be one of the following:
Listed on a recognised stock exchange.
In a company that is not under the control of another company.
In a company that is under the control of a company whose shares are traded on a recognised stock exchange (other than a close company (www.practicallaw.com/4-107-5926) or a company that, if resident in the UK, would be a close company).
This is matches with the conditions that must be met for shares that can be used under an SAYE scheme. However, issues can arise on a change of control where the acquiring company is AIM listed or is a private company (see Practice note, Corporation tax relief for share schemes: loss of relief on takeover by unlisted company (www.practicallaw.com/6-379-0459)).
The tax treatment for an employee holding an SAYE option is as follows:
There is no tax liability on the grant of an SAYE option.
Any savings bonus or, if the savings arrangement is terminated early, any interest payable, is not subject to tax.
There is no tax liability on the exercise of an SAYE option, unless it is exercised within three years of the date of grant as a result of a change of control, reorganisation by way of a scheme of arrangement, winding up or the sale of the employing company.
On a sale of the option shares, CGT may be payable on any gain over the amount paid for the shares (or any gain over the value of the shares at the date of exercise where an income tax charge on exercise applies).
However, in fact, very few individual participants in SAYE schemes make gains that are sufficiently large to bring them into the CGT net (often gains are well within the capital gains tax annual exempt amount (www.practicallaw.com/1-382-5588)).
NICs are not payable, provided that the SAYE option scheme retains its approved status (see Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview (www.practicallaw.com/9-204-9057)).
HMRC takes the view that PAYE does not have to be operated on grant or exercise of SAYE options in any circumstances, provided that the SAYE option scheme retains its approved status.
The accounting treatment of SAYE schemes is considered to be unattractive by many practitioners. In brief, this is because the company cannot adjust the expense it records in its profit and loss account (www.practicallaw.com/6-107-7062) on the grant of an SAYE option if an employee who has started saving under an SAYE savings contract later withdraws from participating. (see Practice note, Accounting for share schemes: an overview: Unattractive accounting treatment of SAYE plans (www.practicallaw.com/9-207-5980)). Despite this potential disadvantage, SAYE option schemes remain popular with both companies and employees, and are used by many listed companies.
For links to standard documents, practice notes, updates and other resources on SAYE option schemes, see Practice note, SAYE options: guide to SAYE content and resources on PLC Share Schemes & Incentives (www.practicallaw.com/0-379-0377).
For a list of Ask the team resources relevant to SAYE schemes, see PLC Share Schemes & Incentives Ask the team archive: SAYE (www.practicallaw.com/3-301-2980).
SIPs (www.practicallaw.com/3-107-7252) are all-employee share plans that provide employees with the opportunity to acquire shares (as opposed to share options). If statutory conditions are met, a SIP can be approved by HMRC and favourable tax treatment can result.
A SIP can have four distinct features:
Free shares.
Partnership shares.
Matching shares.
Dividend shares.
Companies can choose to offer free shares and/or partnership shares. In respect of awards of partnership shares, the company can decide whether to offer matching shares. Any dividends payable on the shares in the SIP can also be reinvested in further shares, known as dividend shares. The shares are acquired upfront (this is different to all other approved share plans, as the participant is a shareholder from the outset), and are held on the participant's behalf in a trust (see The SIP trust).
A company can choose to award up to £3,000 worth of free shares to each eligible employee in a tax year. Allocations can be varied by reference to performance (individual, business unit or corporate) so long as the measures are objective. More specifically, this may be done in one of two ways:
Method 1. Up to 80% of the shares awarded can be performance-linked (the balance being on "similar terms", that is, flat rate or based on service), provided that the highest performance award to any one employee cannot be greater than four times the highest "similar terms" award.
Method 2. All the shares may be awarded by reference to performance, but all awards made within a particular business unit must be paid on similar terms within that unit.
If awards are not performance linked, they must be made on "similar terms".
Employees cannot sell their free shares straight away. Instead, they are normally required to hold them (through the trustee of the SIP) for at least three, but not more than five, years (the holding period must be specified by the company at the time of acquisition). Shares can (but need not) be forfeited if an employee leaves (other than in specified "good leaver" circumstances) within up to three years of the award being made (the forfeiture period (if any) must be specified by the company at the date of acquisition). Any free shares that are not forfeited must be withdrawn from the SIP on leaving employment.
The company may allow employees to buy shares out of their pre-tax income (by deduction from pay) up to a limit of £1,500 per year, or 10% of pay, if lower.
Shares can be purchased either shortly after a salary deduction, or deductions can be accumulated by the trustee for a period (up to one year) with the shares being bought shortly after the end of the accumulation period.
As partnership shares are bought with the employee's own money, they cannot be forfeited. Similarly, there is nothing to prevent employees withdrawing their partnership shares from the trust at any time (although this may have adverse tax consequences).
If partnership shares are offered, consideration should be given to whether a prospectus is required under the EU Prospectus Directive (see Practice note, Does a company need to issue a prospectus if it issues new shares to UK employees? (www.practicallaw.com/4-212-0956)).
Matching shares are additional free shares that the company may choose to award to participants who buy partnership shares.The maximum matching ratio is two matching shares for every one partnership share bought but it can be less (and, in particular, it can be less than 1:1). The matching ratio must be the same for all participants. Matching shares can be capped so that only partnership shares up to a certain value are matched.
Matching shares effectively create a discount on the purchase cost of partnership shares. For example, if one free matching share is given for every four partnership shares, an employee gets five shares for the price of four, representing a 20% discount on each share.
As with free shares, there is a holding period of three to five years (the holding period must be specified by the company at the date of acqusition). Similarly, the matching shares can be awarded on the basis that they will be forfeited if the employee leaves (other than in specified "good leaver"" circumstances) within up to three years of the award being made (again, the forfeiture period (if any) must be specified by the company at the date of acquisition).
Any matching shares that are not forfeited on leaving employment must be withdrawn from the SIP.
The rules of the SIP can specify that dividends paid on an employee's SIP shares may either be passed straight on to the employee or reinvested in the SIP. From 6 April 2013, there is no limit on reinvestment of dividends (before that date, there was a maximum annual reinvestment limit of £1,500) and the three-year limit on reinvestment is removed. Reinvestment may be compulsory or the company may permit participants to choose whether or not they wish to reinvest the dividends. From Royal Assent of the Finance Bill 2013, companies will be permitted to specify the percentage of dividends that must be reinvested. If dividends are reinvested, shares are bought with the dividend payment (dividend shares) and these are subject to a holding period of three years. However, as with all SIP shares, if the employee leaves, the dividend shares must be withdrawn from the SIP.
As with CSOPs and SAYE option schemes, there are complex statutory provisions governing which companies are permitted to adopt an HMRC-approved SIP and the shares that can be used.
As with CSOPs and SAYE schemes, the shares used for the SIP must be ordinary shares. The company whose shares are used for the SIP must be either listed on a recognised stock exchange or free from the control of another company unless that other company is listed on a recognised stock exchange. A SIP can be established either by the employer (using shares in its parent company) or by a parent company.
A SIP must be approved by HMRC before any invitations are issued to participate in the award of any type of SIP shares.
All eligible employees who are both resident and ordinarily resident in the UK must be offered participation. A qualifying period of service may be imposed, but this cannot be more than 18 months. As for SAYE option schemes, SIP rules may allow the company to offer participation to other employees as well.
It is not a requirement that all group companies participate in the SIP, but the selection of the participating companies within a group cannot be used to favour higher-paid employees.
For more information see Practice note, Who can join a share scheme? (www.practicallaw.com/3-205-8988). Employees cannot participate in a SIP if they (or their "associates") have a "material interest" in the company whose shares are used for the scheme, or in certain related companies (see Practice note, Material interest rules for tax-favoured share incentives (www.practicallaw.com/2-338-4952)).
A SIP operates in conjunction with a SIP trust (an employee benefit trust (www.practicallaw.com/6-205-8072) (EBT) which is UK resident and meets other statutory criteria). The trustee acts as custodian for the employees' shares. Normally, it will carry out the bulk of the administration of the SIP, for example, maintenance of records of participants. A number of the large banks and financial institutions have specialist teams that operate these plans and can provide SIP trustee services.
The tax treatment of a SIP is as follows:
The costs of setting up and running the SIP are deductible items for the company.
The market value of free and matching shares at the time they are awarded are deductible items for the purposes of the company's corporation tax liability, provided that the participants are resident and ordinarily resident in the UK.
An award of free and matching shares is not subject to income tax or NICs at the time of award.
Income tax may be due on the withdrawal of free and matching shares from the SIP, depending on how long they have been held and the reason for leaving.
If shares are withdrawn because the employee leaves by reason of injury, disability, redundancy, retirement, death, a TUPE transfer, or the participant's employer ceasing to be an associated company, there is no income tax due.
If shares are withdrawn for any other reason:
If the shares are withdrawn within three years of their award, income tax is due on the market value of the shares at the date they are withdrawn from the SIP.
If the shares are withdrawn between the third and fifth anniversaries of the date of award, income tax is payable on the lower of the market value of the shares at the date of the award and their value at the date they are withdrawn from the SIP.
If the shares are withdrawn more than five years after the date of the award, no income tax is due.
Income tax and NICs are not payable on the amount which is deducted from an employee's pay to purchase partnership shares.
Income tax may be due on the withdrawal of partnership shares from the SIP, depending on how long they have been held and the reason for leaving.
If shares are withdrawn because the employee leaves by reason of injury, disability, redundancy, retirement, death, a TUPE transfer or the participant's employer ceasing to be an associated company, there is no income tax due.
If shares are withdrawn for any other reason:
If the shares are withdrawn within three years of their acquisition, income tax is due on the market value of the shares at the date they are withdrawn from the SIP.
If the shares are withdrawn between the third and fifth anniversaries of the date of award, income tax is payable on the lower of the amount of partnership share money used to acquire the shares and their market value at the date they are withdrawn from the SIP.
If the shares are withdrawn more than five years after the date of the award, no income tax is due.
Cash dividends reinvested in dividend shares are exempt from income tax (although the employee is not entitled to any associated tax credit).
If dividend shares are taken out of the SIP within three years of the date of their acquisition, the dividend originally used to buy them is subject to income tax. This is payable at the dividend rate, through self assessment. No NICs will be due.
Any growth in value of SIP shares is sheltered from CGT whilst the shares remain held in the SIP trust under the rules of the SIP. If shares are sold directly from the SIP, no CGT will arise. If shares are withdrawn from the SIP trust, and later sold, then CGT may be payable on any gain over their value when they came out of the SIP.
Any income tax due in relation to partnership, matching or free shares (but not dividend shares) will be collected under PAYE if the shares are RCAs when they are withdrawn from the SIP (see Operating PAYE).
Broadly, the NICs treatment of SIP shares follows the income tax treatment:
There will be no NICs if no income tax is due.
There will be class 1 NICs if income tax is payable in relation to partnership, matching or free shares (but not dividend shares) if the shares are RCAs when they are withdrawn from the SIP (see Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Share incentive plans (www.practicallaw.com/9-204-9057)).
For a list of Ask the team resources relevant to SIPs, see PLC Share Schemes & Incentives Ask the team archive: SIPs (www.practicallaw.com/3-301-2980).
EMI options (www.practicallaw.com/2-107-6210) enjoy favourable tax treatment and are specifically targeted at small, higher-risk trading companies. For detailed information on the statutory requirements for, and tax benefits of, EMI options, see Practice note, EMI (enterprise management incentives) options (www.practicallaw.com/0-205-7141). EMI options may be granted under a set of plan rules, or by way of stand-alone EMI option agreements. The EMI legislation requires that the EMI option terms take the form of a written agreement between the option holder and the grantor which states the main terms of the option, including how and when it may be exercised.
To qualify to grant EMI options, a company must be an independent trading company with:
Gross assets of no more than £30 million.
Fewer than the equivalent of 250 full-time employees.
Certain trading activities will not qualify and there are detailed rules relating to the independence requirement, the trading requirement and the shares that can be used for EMI options.
To be eligible to be granted an EMI option, an employee must work for the company for at least 25 hours per week, or if less, 75% of his working time.
Employees cannot be granted EMI options if they (or their "associates") have a "material interest" in the company whose shares are used for the scheme, or in certain related companies (see Practice note, Material interest rules for tax-favoured share incentives (www.practicallaw.com/2-338-4952)).
The exercise price of EMI options can be set at less than market value (and can be nil, if option shares are not newly issued). Setting an exercise price that is less than market value at grant has consequences for the tax treatment of the EMI option.
An employee can hold unexercised EMI options over shares worth up to the current EMI individual limit (www.practicallaw.com/4-518-7444).
The EMI legislation requires that EMI options must be capable of being exercised within 10 years of the date of grant, and options can only be exercised within a period of 12 months after the option holder's death. Otherwise, there are no restrictions on the exercise provisions that can apply to EMI options, and this flexibility means that they can be used for exit-only arrangements, as well as for options exercisable at the end of a performance or vesting period.
Apart from the legislative requirements for the exercise of EMI options referred to above (see When can an EMI option be exercised?), there are no restrictions on when EMI options can be exercised or will lapse. However, it is best practice for EMI option agreements to specify exactly when options will lapse, particularly at the end of a window period for exercise. Often, the EMI option agreement will provide that options will lapse on leaving employment, although early exercise may be permitted in certain circumstances.
The EMI option agreement will generally also provide that options lapse if the option holder becomes bankrupt, tries to assign the options or use them as security.
A corporation tax deduction may be available when EMI options are exercised (under Part 12 of the Corporation Tax Act 2009). Relief is given in the accounting year in which the options are exercised and should be claimed by the option holder's employer company (not the company whose shares are acquired, if different).
There are some general requirements for obtaining relief that apply to both the company and employee. The most significant of these is that shares acquired must be one of the following:
Listed on a recognised stock exchange.
In a company that is not under the control of another company.
In a company that is under the control of a company whose shares are traded on a recognised stock exchange (other than a close company (www.practicallaw.com/4-107-5926) or a company that, if resident in the UK, would be a close company).
Issues can arise on a change of control where the acquiring company is AIM listed or is a private company (see Practice note, Corporation tax relief for share schemes: loss of relief on takeover by unlisted company (www.practicallaw.com/6-379-0459)).
In order for an EMI option to qualify for favourable tax treatment, the grant of the option must be notified to HMRC within 92 days of the date of grant, using the form prescribed by HMRC. If the option remains a qualifying option (no disqualifying event has taken place before exercise), the tax treatment for an employee holding an EMI option is as follows:
There is no income tax liability on the grant of the option.
There is no income tax liability on exercise if the exercise price was at least equal to the market value at grant.
If the exercise price was less than the market value at grant, then income tax is due of the difference between the exercise price and the market value at grant.
On a sale of the option shares, CGT may be payable on any gain over the market value at grant.
Shares acquired on the exercise of EMI options on or after 6 April 2012 and disposed of on or after 6 April 2013 qualify for entrepreneurs' relief, with the holding period of the option counting towards the 12 month holding period for the shares required for the relief to apply. For more information, see Draft Finance Bill 2013: enterprise management incentives (EMI) options and entrepreneurs' relief (www.practicallaw.com/1-523-0788).
If a disqualifying event occurs, the tax treatment of an EMI option will be affected, but the tax position will depend on when the option is exercised and whether the option was granted at a discount to market value.
Broadly, the NICs treatment of EMI options follows the income tax treatment:
There will be no NICs if no income tax is due.
There will be NICs if income tax is payable and the shares are RCAs.
The employer and the employee may enter into arrangements under which the employer NICs liability is transferred to the employee (see Practice note, Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Transfer of employer NICs (www.practicallaw.com/9-204-9057)).
For a list of standard EMI option rules and agreements, practice notes, checklists and flowcharts, see, Practice note, EMI (Enterprise Management Incentive) share options: quick guide to EMI content and resources on PLC Share Schemes & Incentives (www.practicallaw.com/6-369-8111).
For a list of Ask the team resources relevant to EMI options, see PLC Share Schemes & Incentives Ask the team archive: EMI options (www.practicallaw.com/3-301-2980).
There are numerous types of unapproved or fully taxable share incentive schemes. These schemes provide share incentives but do not attract favourable tax treatment. They are frequently used as share incentives for senior executives when HMRC-approved schemes may not provide the flexibility or the value of share awards the company requires.
It is rare for executives in listed companies to be able to benefit from an unapproved share incentive arrangement without meeting a performance condition. For more on performance conditions, see Practice note, What is a performance condition?: an overview (www.practicallaw.com/8-205-5483).
These discretionary share option schemes are similar to CSOPs, but do not have any statutory requirements regarding the company, the shares, the employee or the limits on participation. They are therefore much more flexible than CSOPs, and are used by many companies in addition to a CSOP (to grant options above the limits on participation in a CSOP) or as an alternative, where the company or the individual does not qualify for CSOPs.
Many private companies which do not qualify to grant CSOPs use unapproved share options to incentivise employees to work towards an exit (eg a sale or listing) and private company unapproved options are often only exercisable on an exit. In listed companies, unapproved option exercise terms often mirror those for CSOPs, and are generally exercisable after the third anniversary of the date of grant, unless there is a corporate transaction or the option holder leaves the company for a "good leaver" reason. For more on the drafting of unapproved share option plans, see Standard document, Unapproved share option plan rules (www.practicallaw.com/7-374-9049).
There is no liability to income tax.
Income tax is payable on the difference between the market value of the shares on the date of exercise and the option exercise price. If the shares are RCAs, income tax will be payable through PAYE and NICs will also be payable (see Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Unapproved schemes (www.practicallaw.com/9-204-9057) and Operating PAYE).
On a sale of the option shares, CGT may be payable on any gain over the value of the shares at the date of exercise.
Entrepreneurs' relief may be available for employees disposing of shares who own at least five percent of the company's ordinary share capital (and are able to exercise at least five percent of the votes). An employee must have held the shares for at least one year. The effective rate of capital gains tax will be 10% on the first £10 million of gains of this type an employee makes in a lifetime. For more information on entrepreneurs' relief, see PLC Tax, Practice note, Entrepreneurs' relief: an overview (www.practicallaw.com/2-382-4258).
A long term incentive plan (www.practicallaw.com/0-107-6796) (LTIP) is a discretionary share incentive arrangement generally operated by listed companies. LTIPs are also sometimes known as performance share plans (PSPs).
Under an LTIP, shares are awarded to senior executives at nil or nominal cost, usually subject to the satisfaction of a performance condition. Awards can be made in a number of forms, including conditional share awards and nil (or nominal) cost share options (which can be awarded as EMI options if the company and the individual qualify - see Enterprise management incentives (EMI) options).
LTIP awards are sometimes structured so that the executive acquires forfeitable or restricted shares. The executive forfeits the shares if certain conditions are not met or certain events occur. Although these are not as common as share awards or nil-cost options, the complex tax treatment of restricted securities can be attractive in some circumstances (see Practice note, Restricted securities (www.practicallaw.com/3-364-2007)).
As shares are offered to executives under an LTIP at nil or nominal cost, the source of the shares is a particular issue. UK companies are not permitted to issue new shares at less than nominal value, so a nil-cost LTIP award will generally be satisfied using existing shares that are:
Purchased in the market by the trustees of an EBT (see Ask the team: Asking an EBT to satisfy awards made by the company (www.practicallaw.com/1-385-6264)).
Issued out of treasury (www.practicallaw.com/1-107-7413) (see Practice note, Share schemes: using treasury shares (www.practicallaw.com/2-205-2982)).
For more on sourcing shares for share schemes and the relative merits of the different approaches, see Practice note, Sourcing shares for share plans: an overview (www.practicallaw.com/8-205-0145).
Using an EBT to satisfy awards has become more complex following the introduction of Part 7A of the Income Tax (Earnings and Pensions) Act 2003. Whilst it is still possible to use an EBT to satisfy awards under a mainstream share plan such as an LTIP, companies and their advisers should check carefully that either the proposed actions fall within either HMRC's guidance on using EBTs to "hedge" awards, or within an exemption from Part 7A. For more information, see Practice note, Disguised remuneration tax legislation (Part 7A of ITEPA 2003): issues for share plans and other employee benefits: Relevant steps: Earmarking (www.practicallaw.com/4-504-5317).
There is no liability to income tax.
Income tax is payable on the market value of the shares on the date of exercise/vesting. If the shares are RCAs, income tax will be payable through PAYE and NICs will also be payable (see Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Unapproved schemes (www.practicallaw.com/9-204-9057) and Operating PAYE).
On a sale of the LTIP award shares, CGT may be payable on any gain over the value of the shares at the date of exercise/vesting.
Entrepreneurs' relief may be available for employees disposing of shares who own at least five percent of the company's ordinary share capital (and are able to exercise at least five percent of the votes). An employee must have held the shares for at least one year. The effective rate of capital gains tax will be 10% on the first £10 million of gains of this type an employee makes in a lifetime. For more information on entrepreneurs' relief, see PLC Tax, Practice note, Entrepreneurs' relief: an overview (www.practicallaw.com/2-382-4258).
Deferred bonus plans are discretionary share schemes that are normally only operated by listed companies. They generally involve the voluntary or compulsory deferral of an executive's annual bonus into shares that are held in an EBT.
The company may then award the executive a matching award of additional shares or nil-cost share options if performance and service conditions are met. Because of this matching element, some deferred bonus plans are called share matching plans.
The tax treatment of the bonus element depends on whether the bonus is deferred on a pre or post tax basis. To be deferred on a pre-tax basis, the right to the bonus must be given up by the executive before it is deemed earned for PAYE purposes (the rules for a successful bonus deferral are broadly the same as those for salary sacrifice - see Practice note, Salary sacrifice arrangements (www.practicallaw.com/6-287-9952)).
If the bonus is deferred on a pre-tax basis, income tax will arise on the value of the bonus shares when they are released from the plan. If the shares are then RCAs, the tax will be due through PAYE and NICs will also be payable.
If the bonus is deferred on a post-tax basis, income tax and NICs will have been paid on the bonus amount before it was used to acquire bonus shares. Therefore, no income tax or NICs are due when the bonus shares are released from the plan.
There is no liability to income tax on grant.
On the exercise or vesting of a matching share award, income tax is payable on the market value of the shares on the date of vesting/exercise. If the shares are RCAs, income tax will be payable through PAYE and NICs will also be payable.
On a disposal of bonus shares, CGT may be payable on any gain over the value of the shares at the date of purchase (if the bonus was deferred after tax) or the date they were released from the plan (if the bonus was deferred before tax).
On a disposal of matching shares, CGT may be payable on any gain over the value of the shares at the date of vesting/exercise.
Entrepreneurs' relief may be available for employees disposing of shares who own at least five percent of the company's ordinary share capital (and are able to exercise at least five percent of the votes). An employee must have held the shares for at least one year. The effective rate of capital gains tax will be 10% on the first £10 million of gains of this type an employee makes in a lifetime. For more information on entrepreneurs' relief, see PLC Tax, Practice note, Entrepreneurs' relief: an overview (www.practicallaw.com/2-382-4258).
Phantom share options (www.practicallaw.com/3-376-5197) are cash awards the value of which is linked to the value of the company's shares. They are often used by private or overseas companies to grant awards to employees that mirror share options, in circumstances where actual share options are not appropriate or possible. They are generally discretionary plans and are used by public and private companies.
For more information, see FAQ: What is a phantom share option? (www.practicallaw.com/2-382-2184) and Ask the team: Using phantom share options (www.practicallaw.com/1-503-9087).
There is no liability to income tax.
Income tax is payable on the cash amount paid out under the phantom option at the date of exercise. Income tax will be payable through PAYE and NICs will also be payable.
Under a phantom option, the employee is awarded cash rather than shares or other securities, so CGT is not an issue.
Under a joint share ownership plan (JSOP) or shared growth plan, the employee acquires an interest in shares upfront, jointly with another shareholder (usually the trustee of an EBT). Their interests are drawn up so that the employee only benefits to the extent that the shares increase in value above their acquisition value (plus, usually, a carrying charge).
The purpose of a JSOP is for the employee to acquire a CGT asset upfront, so that any growth in value of the shares is charged as a capital gain rather than as employment income. As a result, the value of the employee's interest at the outset is critical, and valuation is an important part of adopting and running a JSOP.
For more information, see Practice note, Joint ownership arrangements: an overview (www.practicallaw.com/5-520-2316).
An employee benefit trust (www.practicallaw.com/6-205-8072) (EBT) is a special type of discretionary trust (www.practicallaw.com/6-107-6128) that is used to benefit employees and former employees (and their dependants) of the settlor company and its subsidiaries. EBTs are used for many reasons, including to provide shares for mainstream employee share plans and to buy shares from departing employees in a private company.
A major reason for using an EBT to satisfy share options and awards is to overcome the company law prohibition against a company issuing new shares at less than nominal value. Another reason particularly relevant to listed companies is that they may not be able to dilute their share capital by issuing new shares for share plans. Shares bought in the market by an EBT to satisfy awards under share plans do not dilute a company's share capital.
For more information on EBTs, see Practice note, Setting up an employee benefit trust: an overview (www.practicallaw.com/3-504-8302).
EBTs may be caught by Part 7A of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) . This is anti-avoidance legislation that was introduced to prevent the use of trusts (and other third parties) to benefit employees and their family members in a way that avoids or defers income tax or NICs. Part 7A of ITEPA 2003 applies from 6 April 2011, although some provisions (mostly relating to loans) apply from 9 December 2010. The legislation imposes an immediate tax charge when a trustee, or other third party, takes certain steps under arrangements that are designed to benefit employees.
Using an EBT to satisfy options and awards has become more complex following the introduction of Part 7A of ITEPA 2003. Whilst it is still possible to use an EBT to satisfy awards under a mainstream share plan, companies and their advisers should check carefully that either the proposed actions fall within either HMRC's guidance on using EBTs to "hedge" options and awards, or within an exemption from Part 7A. For more information, see Practice note, Disguised remuneration tax legislation (Part 7A of ITEPA 2003): issues for share plans and other employee benefits: Relevant steps: Earmarking (www.practicallaw.com/4-504-5317).
For a list of Ask the team resources on EBTs, see PLC Share Schemes & Incentives Ask the team archive: Employee benefit trusts (www.practicallaw.com/3-301-2980).
For a list of documents and drafting notes relating to the establishment and operation of EBTs, see PLC Share Schemes & Incentives Standard documents and drafting notes: Employee benefit trusts (www.practicallaw.com/1-205-8994).
The employer company has responsibility for operating PAYE and for making payments of income tax and NICs due through PAYE over to HMRC. The employer's responsibility is independent of any arrangements it may have with the employee to recover the tax and employee NICs (and employer NICs, if these have been lawfully transferred to the employee (see Practice note, Class 1 National Insurance Contributions (NICs) liabilities and share incentives: an overview: Transfer of employer NICs (www.practicallaw.com/9-204-9057)). As a result, it is very important to ensure that all employee share schemes contain appropriate indemnities for tax and NICs and provisions for recovery of tax and NICs from employees. For more information, see Ask the team: Employees' indemnities for PAYE arising on share incentives (www.practicallaw.com/7-385-0297).
PAYE withholding should be made on the best reasonable estimate of the market value of the shares at the date of vesting of a share award or exercise of a share option (see Ask the team: Best estimates of PAYE liability in relation to employee shares (www.practicallaw.com/4-500-1219)).
Separately from the obligation to withhold, if the employee has not reimbursed the income tax due to the employer within 90 days of the taxable event, this amount is treated as additional remuneration liable to income tax and NICs (see Ask the team: Tax and NICs on PAYE due on a notional payment and not made good (section 222) (www.practicallaw.com/5-505-0365)).
For more information on PAYE and share plans, see Ask the team: Payroll management of PAYE and NICs on share options and other notional payments (www.practicallaw.com/6-385-3480).
Part 7A of ITEPA 2003 is anti-avoidance legislation affecting certain steps taken by EBTs and other third parties. If an action is caught by Part 7A, and income tax charge applies on the value of the step at the date it is taken, then the tax is due through PAYE and NICs are also due.
Part 7A was introduced to stop EBTs and similar structures, such as family benefit trusts (FBTs), from providing benefits to employees and their families in a form which avoided or deferred income tax and NICs. The legislation is very widely drawn, and although there are exemptions for certain types of share plans, such as CSOPs, EMIs, SAYE schemes, SIPs and other unapproved options and awards, the exemptions are complex and narrowly drawn.
Companies using an EBT in conjunction with an employee share plan of any type should seek specialist advice as to whether the arrangements fall within in an exemption from Part 7A. Companies using an EBT or an FBT to provide other benefits to employees or their families should seek specialist advice before taking any further steps in relation to the EBT or FBT.
For more information on Part 7A, see Employee benefit trusts (EBTs) and Practice note, Disguised remuneration tax legislation (Part 7A of ITEPA 2003): issues for share plans and other employee benefits (www.practicallaw.com/4-504-5317).
Most share plans are set up as employees' share schemes (www.practicallaw.com/6-107-6213) for company law purposes, as this gives exemptions from some important company law requirements (see Ask the team: Benefits of a share plan being an employees' share scheme (under the Companies Act) (www.practicallaw.com/1-381-2048)).
For public companies, financial assistance (www.practicallaw.com/6-107-5751) is also an issue when funding an EBT to buy shares for share plans. For more information, see Practice note, Funding employee benefit trusts: financial assistance, UITF Abstract 38 and international accounting standards (www.practicallaw.com/4-205-2981).
The Financial Services and Markets Act 2000 (FSMA 2000) prohibits an unauthorised person from carrying out regulated activities and making financial promotions. Activities in relation to employee share plans may fall within the scope of one or both prohibitions, but there are exemptions from the prohibitions that may assist. If an exemption does not apply, activities and communications must be signed off by an authorised person, and failure to comply is a criminal offence, so it is important to ensure that a particular share plan falls within an exemption from the FSMA 2000 prohibitions. For more information, see Practice note, Financial services (FSMA 2000) regulation and the operation of share plans (www.practicallaw.com/0-382-2057).
In some circumstances, a company may need to issue a prospectus if it proposes to offer shares to employees under an employee share plan. There is an exemption from the requirement to issue a prospectus for certain offers to employees made by EEA registered companies and non-EEA companies listed on an "equivalent" market. For more information, see Practice note, When is a prospectus needed for an offer to employees? (www.practicallaw.com/4-212-0956) , .
Companies listed on the London Stock Exchange must comply with the Listing Rules (www.practicallaw.com/7-107-6774) and the Model Code (www.practicallaw.com/7-107-6854), and certain sections have an impact on the adoption and operation of share plans. For more information, see Quick guide: Share scheme issues for listed companies (www.practicallaw.com/7-381-9419) and Practice note, Listing Rules: employee share schemes aspects (www.practicallaw.com/4-382-0184).
The ABI remuneration principles (www.practicallaw.com/2-205-8149) are also generally adhered to by fully listed companies (and by many AIM listed companies). For more information, see ABI remuneration principles: new version published (www.practicallaw.com/5-522-6384).
The tax position of employees who benefit from share plans who are internationally mobile (for example, that that are resident but not ordinarily resident in the UK) is complex.
For more information, see Practice note, Remittance of securities and options income to the UK and the treatment of UK shares (www.practicallaw.com/7-382-7749).
Dealing with the effect of a corporate transaction on the holders of option and awards under employee share plans can be complex and time consuming, particularly if there are a large number of employees involved.
The company will need to identify how the proposed transaction affects employees participating in different share plans, communicate with the employees about the proposals, follow the employees' instructions in relation to the transaction and withhold and account for any tax and NICs due on the transaction under PAYE.
Thorough due diligence is essential, to understand exactly who is affected by the transaction, and the tax and other consequences that may arise. The exact issues, process and tax liabilities will depend on the type of transaction and the type of share plan involved. For more information on specific types of transactions, see: