Sharesave appears to be more popular with the lower-paid, and while Sips are growing significantly, these still remain more attractive to individuals with higher salaries, says Matthew Stibbe
Case Study: eCourier
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Employers looking to implement an HM Revenue & Customs (HMRC)-approved share scheme can take their pick from four types of plan. These are all tax-efficient ways for companies to reward staff with shares, either directly or through options, although each has a different mechanism and target audience. And employers are not constrained to just one choice because the schemes can be used individually or in combination with one another. Choosing the right plan requires careful planning and expert advice. The problem for most benefits staff is understanding the various schemes that are available.
The sharesave scheme, which combines a savings plan with options, is the longest-running HMRC-approved scheme and the most popular. Employees build up funds to allow them to exercise the options when they vest and it is an easy way to build up shareholdings and tax-free savings. If the options are above water staff can buy the shares and sell them at a profit or keep them. However, the scheme is particularly attractive because employees can get their cash back at any time which means it is very low risk.
But because it is option-based and relatively inflexible, it is slowly being eclipsed by share incentive plans. Julian Foster, head of specialist services at Halifax Share Services, says: "A company may perceive that the individual isn’t bearing any risk and the company is bearing all the cost, especially with the new rules." Evidence suggests that sharesave is more popular with lower-paid employees and while Sips are growing significantly in popularity these still remain more attractive to better-paid individuals. Sharesave schemes have two components: a three- or five-year-long monthly savings plan and a share option grant. The scheme has to be offered to all employees on the same terms. Participating employees can withdraw from the scheme at any time in which case all the savings are returned to them plus interest. If they stay in the scheme until it matures, however, staff can either withdraw the savings with the tax-free bonus once the scheme has matured if the options are under water or use the savings to purchase shares. There is no income tax charge on the grant or exercise of options and, as an incentive, options can be granted at a discount of up to 20% off the market value.
Launched in 2000, the key difference between sharesave schemes and Sips is that employees own whole shares immediately. This means that they share the risk as well as the rewards of share ownership. Company matching shares or free shares can mitigate the risk somewhat and make the scheme more attractive but at a cost to the employer.
Like sharesave schemes, share incentive plans (Sips) are all-employee schemes. This often makes it less attractive for private companies, however, because it is based on whole shares it is currently attracting favour in large companies faced with the new accounting standards from the International Accounting Standards Board, which came into effect earlier this year. Sips can combine free shares with shares bought by the employee, hence they can offer more flexibility than sharesave schemes and can be tailored to meet different requirements. The downside is their complexity which makes HMCR approval more challenging. Sips are gaining in popularity and have been adopted faster than sharesave schemes were in the first five years of its existence. Justin Cooper, head of share plans at Capita, says: "I think that’s partly driven by the fact that it is the most flexible all-employee share plan. We refer to it as a shopping basket of opportunities for companies."
Sips are also inherently flexible and employers can pick and choose the components they want in their scheme. A fully-loaded Sip allows employees to receive up to £7,500 worth of shares each year. This is made up of: up to £3,000 of free shares given by employers, £1,500 of partnership shares paid for out of the employee’s pre-tax salary and up to £3,000 of matching shares up to a ratio of two matching shares to each partnership share. In addition, dividends can be paid to employees and taxed in the normal way or they can be used to purchase dividend shares within the plan up to a value of £1,500 a year.
Sips also have several tax advantages. If shares are held for five years, no income tax or national insurance (NI) charges arise, however, different rules apply to early withdrawals and employee departures. Capital gains tax only applies on the uplift in value of shares after they are withdrawn from the plan and employers obtain a corporation tax deduction for the cost of free and matching shares, gross salary used to buy partnership shares and the costs of setting up and running the scheme.
Finally, employers can include forfeiture provisions on matching shares if employees leave and there is a limited provision for performance measures in determining a grant of free shares.
Enterprise management incentive schemes are a tax-efficient way for growing companies to give options to key employees.
EMI is a particularly attractive option for fast-growing private companies looking to attract staff without attracting crippling salary bills because it gives the prospect of paying only 10% tax on gains – after full capital gains tax taper relief. "EMI has been hugely successful. The Revenue cut out a lot of the red tape and approval procedures. You don’t have to have the plan approved up front; you enter into the contract and then notify the [tax office]," explains Capita’s Cooper.
However, it was never designed for the FTSE 250 and, being option-based, it is subject to the new accounting rules.
EMI schemes are targeted at small, entrepreneurial companies and designed to help recruit senior employees. This explains many of the restrictions placed on it, for example, it is not available to companies with gross assets greater than £30m. In addition, companies in certain sectors, such as property, and employees who work less than 25 hours a week for the company or who – if they work part-time – spend less than 75% of their working time at the company are also excluded. And no participant may hold more than 30% of the shares in the company. Otherwise, the company can decide who participates and to what extent. The maximum holding under the scheme is £100,000 (valued at the time of the option grant) and, as with company share option plans, options must vest and be exercisable within 10 years.
But the tax benefits are attractive. There are no income tax or NI charges when options are granted, even if granted at a discount to market value. However, if options are granted at market value or above, they can be exercised without incurring income tax or NI charges. Capital gains tax taper relief, meanwhile, begins from the date of grant, not date of exercise and shares count as business shares for taper relief.
Company share option plans are discretionary share option schemes. This means that, unlike sharesave schemes and Sips, the company can decide who receives the benefit and to what degree. Ross Welland, a partner at Horwath Clark Whitehill, says: "It is less generous in its reliefs than EMI, and less flexible in the way the rules can be drafted." Csops’ main use is where a company does not qualify for EMI because of the size or nature of its business. For quoted companies, it can be a useful benefit for senior staff, although the £30,000 limit on options under the scheme means that it is likely to be of modest value to senior management.
Leslie Moss, an associate at Hewitt, says: "We take the view that the extra complication of a Csop is modest. It’s a very standard plan and the Revenue is used to them. You’re throwing away a valuable tax relief by not implementing it." Often, firms will use a Csop to gain tax advantages for the first tranche of options before moving to an unapproved scheme for subsequent grants.
It is likely to be the scheme that is most affected by the IASB’s new accounting standards because it is an all-option plan. And other forms of long-term incentives and stock appreciation rights become increasingly popular once the tax benefits of the Csop have been exhausted.
Overall, Csops are relatively straightforward schemes. The main limitations are that the shares used for the plan must be part of the company’s existing share capital and have the same rights as other ordinary shares. Options can only be granted to employees or directors with less than 25% of the company’s share capital and they must vest and be exercisable within 10 years. A firm can grant options up to a maximum of £30,000 to an individual; with the option price based on the market value at the time of grant. It also attracts tax benefits with no income tax charges arising when the options are exercised,although special rules apply to leavers and other special cases.
Case Study: eCourier
eCourier uses its enterprise management incentive (EMI) scheme in place of cash to recruit key staff. The scheme is also central to the logistics firm’s structure. Tom Allason, managing director, explains that it wanted to take a progressive approach to rewarding staff. "We’re structured as a tech company rather than a courier company. The capital structure of the company is built around the EMI. We gain our equity stakes wholly through EMI options."
It recently used the ability to grant EMI-blessed options to recruit a highly-qualified general manager for substantially less than his previous salary.
"Our most valuable asset is our human resources. We can’t afford to go second rate. If they’d rather have cash they’re probably not the right people for us," says Allason.
The company made its first delivery in September 2004 and has been through several rounds of financing. However, the scheme is not without its drawbacks, specifically setup costs and the onerous requirement for having an employee benefit trust.