Employee share schemes: a quick guide
Do you know your CSOPs from your LTIPs? This quick guide summarises the various employee share incentive schemes available to UK companies and highlights some of the regulatory and other issues which can cause difficulties for share plans.
This is one of a series of quick guides (see Quick guides).
Why do companies use share schemes?
Key reasons are financial and motivational
Employee share incentive plans can be a tax-efficient way to remunerate employees. They can therefore help reduce employment costs. They are used to recruit, retain and motivate employees and improve staff performance. Share incentives can also help to align the interests of senior executives with those of shareholders by encouraging them to consider shareholders' interests in managing the business. They can also help private companies with succession or exit planning.
What different types of share plans are available?
There are tax-favoured and non tax-favoured arrangements
Some employee share schemes benefit from favourable tax treatment (tax-favoured schemes). These are described below (see Tax-favoured schemes). Tax-favoured arrangements can also be divided by which employees 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 invited to participate (discretionary schemes).
There is a range of other share incentive arrangements which do not attract any tax advantages (non-tax favoured, unapproved or fully taxable schemes), but which companies find useful for their flexibility. Whilst a company could adopt an unapproved all-employee plan, generally fully taxable plans are discretionary. These are described below (see Unapproved (fully taxable) schemes).
Company share option plans (CSOPs)
Under a company share option plan (www.practicallaw.com/1-107-5956) (CSOP), employees are granted share options (rights to acquire shares in the future at a price fixed at the time of grant). The employee makes no initial financial commitment or future obligation to exercise the option. CSOPs are discretionary schemes, so that CSOP options do not have to be offered to all employees. If the statutory conditions are met, there is no income tax or NICs on the exercise of a CSOP option, but capital gains tax may be payable on the sale of the option shares. For more information, see Practice note, Employee share schemes: an introduction: Company share option plans (CSOPs) (www.practicallaw.com/9-107-4444).
Save as you earn, sharesave, or savings-related share option schemes (SAYE)
In a SAYE option scheme (www.practicallaw.com/4-107-7195) scheme, the employee agrees to save a certain amount each month for a specified period. The employee then uses the proceeds of his savings to buy shares. If the employee does not want to buy shares, he can choose to have his savings and a tax-free bonus paid out in cash. SAYE option schemes are all-employee schemes, so participation has to be offered to all qualifying employees. If the statutory conditions are met, there is no income tax or NICs on the exercise of an SAYE option, but capital gains tax may be payable on the sale of the option shares. For more information, see Practice note, Employee share schemes: an introduction: SAYE, Save as you earn, sharesave, or savings-related option schemes (SAYE) (www.practicallaw.com/9-107-4444).
Share incentive plans (SIPs)
Share incentive plans (www.practicallaw.com/3-107-7252) (SIPs) enable employees to acquire shares (as opposed to share options) in their employer company (or its parent company). The company can offer partnership shares, which employees buy out of their pre-tax income, additional matching shares on partnership shares or free shares. Dividends on the shares can also be reinvested in the SIP in further shares, known as dividend shares. SIPs are all-employee schemes, so participation has to be offered to all qualifying employees. There are holding periods for each type of SIP shares, and if these are met, there is no income tax or NICs when shares are withdrawn from the SIP, and growth in value of the shares whilst they are in the plan is sheltered from capital gains tax. for more information, see Practice note, Share incentive plans: an overview (www.practicallaw.com/4-501-1614).
Enterprise management incentives (EMI) share options
EMI (www.practicallaw.com/7-107-6533) share options are specifically targeted at small trading companies. EMI options are discretionary, so they do not have to be offered to all employees. There are specific statutory conditions for which the EMI company and the employee must meet. If options qualify as EMIs throughout, and options are granted with an exercise price equal to the market value at grant, there is no income tax or NICs on the exercise of an EMI option, but capital gains tax may be payable on the sale of the option shares. Listed companies and private companies can qualify to grant EMI options, but all companies will need to review the rules carefully in the light of their ownership structure, articles of association and trading activities. For more information, see Practice note, EMI (enterprise management incentives) options (www.practicallaw.com/0-205-7141).
Unapproved (fully taxable) schemes
Unapproved share option schemes
Unapproved share option schemes are generally discretionary and are available to most public and private companies. Income tax and NICs will be payable on the exercise of options, and capital gains tax may be due on the sale of the option shares. Unapproved plans are very flexible - there are no statutory provisions governing their terms. For more information, see Practice note, Employee share schemes: an introduction: Unapproved or fully taxable share schemes (www.practicallaw.com/9-107-4444).
Long-term incentive plans (LTIPs)
Long term incentive plans (www.practicallaw.com/0-107-6796) (LTIPs) (also called performance share plans (PSPs) are discretionary share schemes under which nil or nominal cost share awards or share options can be granted. They can be operated by most listed companies, but they are not generally used by private companies. Income tax and NICs will be payable on the exercise of options or vesting of share awards, and capital gains tax may be due on the sale of the plan shares. LTIPs are very flexible - there are no statutory provisions governing their terms. The main concern for companies operating LTIPs is sourcing the shares to satisfy awards, as companies cannot issue shares at less than their nominal value. Often companies use an employee benefit trust (www.practicallaw.com/6-205-8072) (EBT) to buy existing shares to satisfy LTIP awards, but anti-avoidance legislation in Part 7A of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) has made the use of EBTs for share plans more difficult (see Practice note, Disguised remuneration tax rules and employee share plans: a quick guide (www.practicallaw.com/7-505-6899)).
Deferred bonus, co-investment or share matching plans
Deferred bonus plans involve the voluntary or compulsory deferral of an executive's annual bonus into shares which 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. Deferred bonus plans are discretionary share schemes which are normally only operated by listed companies. Income tax and NICs will be payable on the vesting of the bonus and matching shares (or the exercise of matching share options) and capital gains tax may be due on the sale of the plan shares. Deferred bonus plans are very flexible; there are no statutory provisions governing their terms (although companies must be careful to ensure that bonuses are deferred before they are deemed earned for tax purposes. Similar issues will arise to those for LTIPs about Part 7A of ITEPA 2003 and about sourcing shares for the matching element (see Long-term incentive plans (LTIPs)).
Plans under which phantom share options (www.practicallaw.com/3-376-5197) or awards can be granted are often used by companies that are restricted (by law or their own constitution) from using actual shares to reward employees. Phantom plans can be structured to mirror unapproved share options and LTIPs. They are discretionary plans that can be operated by listed or private companies. Income tax and NICs will be payable on the vesting of phantom awards or the exercise of phantom options. As awards are settled in cash, there will be no capital gains tax issues. Phantom plans are very flexible; there are no statutory provisions governing their terms. Part 7A of ITEPA 2003 will be an issue if the awards or options are satisfied by a third party such as an EBT.
Joint ownership or shared growth arrangements
Joint ownership arrangements are generally structured so that the employee acquires an interest in the underlying shares jointly with an EBT trustee, paying a small upfront amount to acquire the interest. The employee is entitled to the benefit of the growth in value of the shares, above a threshold "carrying charge". These arrangements are discretionary and can be operated by listed or private companies (although the valuation of the interests is the most difficult issue for both public and private companies). Joint ownership arrangements are intended to ensure that any growth in value of the underlying shares after acquisition is taxed as a capital gain rather than as employment income.
Other issues to consider when adopting and running a share plan
- Part 7A of ITEPA 2003, which imposes income tax and NICs charges, through PAYE, on certain benefits provided though an EBT.
- Company law, including financial assistance (www.practicallaw.com/6-107-5751) rules.
- Financial services law, including the Prospectus Directive.
- The Listing Rules (www.practicallaw.com/7-107-6774), Model Code (www.practicallaw.com/7-107-6854), ABI remuneration principles (www.practicallaw.com/2-205-8149) and other corporate governance guidelines.
- Internationally mobile employees.
- The effect of corporate transactions.
- Accounting for share plans.
- Share valuation issues.
Detailed notes on these issues are available at Practical Law Share Schemes & Incentives.
Below is a selection of Practical Law's introductory materials on share plans:
- Employee share schemes: an introduction (www.practicallaw.com/9-107-4444).
- EMI (Enterprise management incentives) share options (www.practicallaw.com/0-205-7141).
- When is a prospectus needed for an offer to employees? (www.practicallaw.com/4-212-0956).
- Financial services (FSMA 2000) regulation and the operation of share plans (www.practicallaw.com/0-382-2057).
- Listing Rules: employee share schemes aspects (www.practicallaw.com/4-382-0184).