InvestmentsApr 30 2019

A slice of the pie: The rise of employee share schemes

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A slice of the pie: The rise of employee share schemes

Employers may want to offer their employees and directors a stake in the company, and there are various schemes available, all with different tax treatments. 

Save as you earn

Under a save-as-you-earn scheme, an employer can grant eligible employees and directors the option of purchasing company shares in the future for a price fixed at the start of the scheme. SAYE schemes may run for three or five years.

Eligibility

The employer may specify a minimum employment period of up to five years for employees and directors to qualify for the scheme. All individuals meeting that employment condition must then be offered the chance to participate in the scheme, on similar terms. 

The options are granted at a discount of up to 20 per cent of the market value on the date the options are granted. This is the ‘exercise price’. Participants can save up to £500 a month into SAYE schemes.

Tax treatment

There is no income tax or national insurance relief on the monthly savings, which is usually taken out of the participant’s net salary through pay as you earn.

At the end of the contracted savings period (the maturity date), the participant may either exercise their options or take the cash. If cash is taken, any interest that has accrued would be tax-free. The interest rate on SAYE schemes is set by HM Revenue & Customs and has been at zero per cent for a number of years.

If the participant chooses to exercise the options the shares will be purchased in their name. The base cost for capital gains tax purposes will be the price paid for the shares, not the market price at date of exercise.

Time limits

If the participant leaves the company before three years their option will lapse, unless the reason for leaving falls within the ‘good leaver’ provisions (see Box 1). 

If the participant is in a five-year scheme but leaves the company after three years, they may be able to exercise the options within the following six months.

The option to take cash means there is no market risk during the SAYE period, although the lack of interest means there is inflationary erosion of value and missed investment opportunity. The options must be exercised within six months of the maturity date otherwise they lapse and the cash savings are returned to the participant.

Share incentive plan

With a SIP, the employer awards shares to participants that are held in trust. Unlike SAYE, the shares are granted at the outset and there is no cash alternative available.

There are four different types of shares awarded under SIPs. The company can choose to offer qualifying employees and directors any combination of:

1) Partnership shares – the participant can opt to buy partnership shares out of their gross salary. The maximum allowed per tax year is the lower of £1,800 a year, or 10 per cent of the salary in the tax year.

2) Free shares – the maximum per tax-year is £3,600. The award may be linked to the employee’s performance.

3) Matching shares – the employer may choose to give up to two matching shares for every partnership share the participant purchases.

4) Dividend shares – cash dividends on the shares held in the SIP on behalf of the participants may be reinvested within the plan, tax-free, into more shares. Dividend shares must be held in the trust for three years, after which participants can sell the shares. Any dividends that are not reinvested are taxable on the participant in the same way as any other dividend income. 

Eligibility

The company can specify a minimum period of employment of up to 18 months to be eligible to participate, but otherwise all qualifying employees and directors must be invited to participate on the same terms as one another.

Free shares can be restricted to selected employees and directors with reference to the individual’s remuneration, length of service and hours worked.

Tax treatment

There is no income tax or NI liability when SIP shares are awarded. The participant can take the shares out of the plan before five years, but may then need to pay income tax and NI. If shares are taken out of the plan after three years, the participant would normally pay income tax and NI on no more than the initial market value of shares.

Participants who keep the shares in a SIP for five years (three for dividend shares) pay no income tax or NI when they take their shares out of the plan. If the shares are sold within the plan, any gain is not assessed against CGT on the participant. The individual’s base cost for CGT purposes is the value when the shares exit the plan. 

If the shares have been taken out of the plan and then later disposed, any increase in the value between the date of exit and date of disposal will be assessed against CGT.

Tax-planning opportunities

Normally, Isa and pension subscriptions – such as the use of self-invested personal pensions in the latter case – must be made with cash, hence the use of ‘bed and Isa’ and ‘bed and Sipp’ to minimise the time out of the market. 

Isa and pension subscriptions can be made in specie from SIP and SAYE schemes within 90 days of the relevant date. 

For SAYE schemes, the 90-day period starts on the date that the participant exercises the option. For SIPs, the 90-day period starts on the date the shares cease to be subject to the plan, which is the point at which the shares are taken out of the trust and moved into an account held in the participant’s own name.

In addition to removing the market risk and costs of trading to fund the Isa by cash, an in-specie contribution will not be a disposal for CGT purposes.

Similar to the Isa, SAYE and SIP shares can be used to make an in-specie contribution to a pension scheme within 90 days of the relevant date. However, unlike for the Isa this will be a disposal for CGT purposes. See Box 2 for an example.

If a SAYE or SIP scheme is ending in the current tax year, it could well be worth holding back enough Isa allowance to take advantage of this favourable CGT treatment.

Victoria Harman is senior technical expert at Hargreaves Lansdown