Companies sometimes grant share options to their employees as part of their overall remuneration package. As well as incentivising staff, they can provide tax benefits to employees and the business. We will consider the ins and outs of share options in this blog post.
What are share options?
Share options are essentially an agreement under which a company grants a third party (usually an employee) the option to purchase a certain number of company shares at a specified date in the future.
The options are normally for a fixed price, known as the ‘exercise price’, and often under specific conditions, e.g., that the company has achieved a certain level of profitability over a set timescale.
Because the exercise price is often fixed at the time the share options are granted, the theory is that employees will be incentivised to work harder to improve company profitability. Therefore, increasing the share price, whilst allowing them to purchase the shares for a lower cost than their new value, will lead to them making a profit.
Although share options are often used as part of a benefits package for employees, e.g., as an alternative to a bonus scheme or a higher basic salary, they are sometimes also granted to company directors or third-party investors. But it’s the schemes for employees that are most often discussed in relation to share options, as these can also provide tax benefits.
What are the main share option schemes available?
There are three main types of share option schemes for employees:
Enterprise Management Incentives (EMIs)
Enterprise Management Incentive schemes (EMIs) allow a company to grant options up to the value of £250,000 for each individual employee, calculated over a three-year period.
Employees granted the options will be entitled to exercise their options, i.e. purchase a specified number of shares at a fixed price, upon a ‘trigger’ event. Examples of trigger events are:
- sale of the company
- a company achieving a certain market valuation
- specified performance targets being met by the employee
EMIs are available to companies whose assets are not in excess of £30 million. Furthermore, there should be fewer than 250 employees.
EMIs are discretionary, meaning that they do not need to be offered to all employees. Companies cannot offer EMIs if they are involved in any of the following ‘excluded activities’:
- property development
- provision of legal services
There is no Income Tax or National Insurance (NI) payable on EMI options, as long as the shares are purchased for at least the market value they had when the option was granted. However, if there is a discount on the market value, Income Tax, and NI needs to be paid on the difference.
The cost of setting up and administering the EMI scheme is classed as an allowable business expense – so Corporation Tax relief will be available.
Save As You Earn (SAYE)
Save As You Earn (SAYE) schemes, also called ‘savings related share option schemes’ or ‘sharesave,’ are designed to allow employees to save money tax-free in order to purchase company shares.
SAYE works in tandem with share options which are granted by the company. The scheme is not discretionary; it must be offered to all eligible employees and company directors.
Under the scheme, employees can save up to £500 per month as part of a ‘savings contract’ which lasts for either 3 or 5 years. Once the fixed period of the savings contract has finished, employees can then exercise their option to purchase shares at a fixed price.
No income tax or NI is payable for the difference between the market value of the shares and the fixed price at which they were purchased.
Furthermore, any bonus or interest received under the savings contract is free of tax. But there may be Capital Gains Tax (CGT) to pay if the shares are later sold unless they are transferred into (i), an Individual Savings Account (ISA) within 90 days of purchase, or (ii), a pension immediately upon purchase.
Company Share Option Plan (CSOP)
A Company Share Option Plan (CSOP) allows companies to grant share options to employees and directors worth up to £30,000 each. There is no income tax or NI payable on the difference in the market value of the shares when they are purchased and the exercise price, although CGT may need to be paid if the shares are later sold.
Unlike SAYE schemes, CSOPs are discretionary; the company can select certain individuals to whom it wishes to grant the options.
Unapproved share option schemes
In addition to the share option schemes mentioned above, which are all approved by HMRC and need to meet certain criteria, some companies decide to set up alternative schemes which are not approved by HMRC.
The main difference between approved and unapproved schemes is that tax benefits are generally only available to employees using approved schemes.
How to set up a share option scheme
Companies must first gain approval from shareholders before they can set up a share option scheme.
Since options, once taken up, will create new shareholders, there may be issues regarding the dilution of voting rights to consider. Approval must also be sought for the terms of the share option scheme (subject to any restrictions and criteria set by an approved scheme), such as:
- Eligibility – which employees (or other individuals) are eligible to take part in the scheme (note that SAYE schemes must be offered to all employees).
- Loss of option – whether the option is lost under specified circumstances, such as if the employee who has been granted the options resigns or is sacked.
- Exercise price – this is the fixed price at which the shares can be purchased (often the market price at the time the option was granted).
- Exercise period – this will generally specify the period during which employees can exercise their options (e.g. shortly following a company valuation).
- Trigger event – if an event must first occur before the options can be exercised.
Once shareholder approval has been granted, it will also be necessary to gain the relevant approvals from HMRC (if it is an approved scheme). This may involve obtaining an initial market valuation of the company. Share option agreements will then need to be drawn up. This can be a complex process and professional advice should be sought.