In recent years, various provisions have been introduced to both increase the attractiveness of share incentive schemes to reward and retain staff, and to limit their effectiveness.

The purpose of this article is to provide a basic summary of the main forms of share incentive scheme and a short summary of the salient tax aspects of each. It goes without saying, however, that anyone considering introducing a share incentive scheme should seek specialist advice in this area to ensure that the scheme is tailored to the requirements of the employing company.

There are many different forms of share incentive schemes, but they can be broken down into two main ones: approved and unapproved.

Approved schemes are often referred to as ‘tax-advantaged schemes’, due to the fact that they confer certain tax breaks on the recipients. As they do have HMRC approval and tax advantages, the rules concerning them tend to be more rigorous and the qualifying criteria less flexible.

Unapproved schemes do not offer any tax advantages. However, this means that they can be far more flexible and have fewer restrictions/limits than approved schemes.

Phantom share schemes

These aren’t really share incentive schemes as no actual shares are issued. Employees are allocated a number of imaginary shares that have a market value (linked to the actual price of the company’s shares or calculated according to a set formula). At certain intervals, the shares are revalued and the increase in the market value of the shares is paid to the employee as a cash bonus through the payroll.

This is relatively cheap to administer, reporting requirements are minimal and the taxing mechanism (payroll), is already in place.

Unapproved schemes

The employer has discretion over who can benefit from the options, the amounts over which options can be granted and the exercise price. Income tax is normally paid at the point of exercise and is charged on the difference between the market value of the shares at the point of exercise and the actual amount paid for them.

PAYE and NICs have to be accounted for by the employing company if the shares acquired are deemed to be ‘readily convertible assets’ (broadly speaking, if shares can be traded on a recognised exchange or there are arrangements in place to sell the shares).

Approved schemes

The advantage of approved schemes is that, ordinarily, an income tax charge does not arise at the time that the option is exercised. Capital Gains Tax (CGT) is charged at the point of disposal of the shares.

The rate charged is therefore lower than income tax rates and, depending upon the type of incentive scheme, Entrepreneurs’ Relief might be available to reduce the rate of tax to as little as 10%.

There tends to be more reporting requirements with approved options which include the following:

Share Incentive Plans (SIPs)

All employees must be invited to participate and there must be no preferential terms for directors or senior employees. The scheme is operated via a trust, and both the company and employees must satisfy eligibility criteria.

Three types of share can be issued under the plan: free shares, which are issued to the employee; partnership shares, which the employee can purchase; and matching shares, which can be awarded in proportion to partnership shareholdings.

There are no tax/NIC charges at the point of award, and withdrawal of shares from the plan within five years can result in tax/NIC charges. The company can obtain tax deductions for certain costs relating to the scheme.

Save As You Earn options scheme (SAYE)

All employees must be invited to participate. Employees save from £5 to £250 per month over a three, five or seven year period. At the end of the contract the savings and a tax-free bonus are used to acquire shares at an agreed price. The option cannot be exercised before the bonus date. There are potential income tax charges where the option is exercised within three years of grant; the company can obtain tax deductions for certain costs relating to the scheme.

Company Share Option Plan (CSOP)

The company has discretion over who can participate. The scheme has to be approved in advance by HMRC and the maximum value of qualifying options per employee is £30,000. The option price cannot be markedly different to the market value at the date of grant and must be stated at the time of grant. The option must be exercisable no earlier than 3 years and no later than 10 years from the date of grant. The company can obtain tax deduction at the point the shares are acquired by the employee.

Enterprise Management Incentives (EMI)

Options can be targeted to specific employees. The company, employees and the type of shares must satisfy eligibility criteria. The maximum value of shares over which an employee can hold EMI options is £250,000 and a company cannot issue EMI options in excess of £3m worth of shares.

The terms of the EMI options have to be set out in a formal agreement or deed. To mitigate any income tax charge at exercise, the option price must be at, or close to, market value at the date of grant. Options must be capable of exercise within 10 years from the date of grant. If the rules are satisfied, CGT will only become relevant upon disposal. Formal valuation and assurance procedures are available.