Tax advantaged share option schemes involve employees or full time directors being granted options to buy shares in the company which employs them at a set exercise price. The grant of an option is when the option is given to the employee, and exercising the option is when the option is used to purchase a share in the company for the exercise price.
There are four types of approved tax efficient shares scheme which are:
1. Share Inceptive Plans (SIPs) (Schedule 2 ITEPA 2003)
2. SAYE Option Schemes (SAYE) (Schedule 3 ITEPA 2003)
3. Company Share Option Scheme (CSOP) (Schedule 4 ITEPA 2003)
4. Enterprise Management Incentives (EMI) (Schedule 5 ITEPA 2003)
Scheme 1 involves employees being given shares whereas Schemes 2 to 4 involve share options. If share options are given by any other scheme or method then they will not be in a tax advantaged position.
In order for a tax advantaged scheme to be eligible the plan must be approved by HMRC within a certain length of time following the grant of the options. For unquoted companies HMRC can also be used in advance to determine the value of the shares being agreed at the date of the grant.
Share Incentive Plans (SIPs)
HMRC Manual ETASSUM20000
A SIP allows a company to give free shares to its employees. The shares are put into a plan or a trust, and in order for there to be no tax or National Insurance payable then the shares must stay inside of the trust for at least 5 years.
If the shares are withdrawn within 3 to 5 years of being placed in the trust then there will be a charge to income tax, as well as National Insurance if the company is quoted, which will be based upon the lower of the value at the date of grant and the market value at withdrawal.
If the shares are withdrawn within 3 years of the date of the grant then they will be subject to tax, and National Insurance if the company is quoted, based on the market value of the shares at withdrawal.
A company can provide its employees with up to £3.6k per annum of free shares, and each employee can purchase up to £1,800 (capped at 10% of salary) out of their gross pay in additional shares. These purchased shares are referred to as partnership shares.
Any dividends received whilst the shares are in the trust will be tax free if they are invested in more partnership shares, and these shares remain in the trust for at least three years.
The gain on these shares is taxable based on the proceeds of the share sale less the Market Value at withdrawal, as such if the shares are sold on the same day as they are withdrawn then there will be no charge to capital gains tax.
This scheme must be available to all employees and in order for there to be no tax payable then the shares must remain in the trust for at least 5 years.
HMRC Manual ETASSUM 30000
A SAYE scheme involves an employee saving a monthly amount from their net salary, up to £500 per month, which is saved for the length of the scheme which will be 3 or 5 years. At the end of the scheme the shares are then purchased at a price agreed at the start of the scheme period, which can be at up to a 20% discount over the Market Value at the date of commencement.
Any interest that is earned on the saved income over the period is not subject to tax or national insurance, and the gain on disposal of the shares will be calculated as the proceeds less then exercise price paid for the shares.
All employees must be allowed to participate in this scheme, although a minimum employment period can be set by the employer.
HMRC Manual ETASSUM40000
A CSOP scheme allows the company to choose which employees/directors it wishes to offer the share options to; however they must be a full time director or an employee of the company. The maximum that can be granted to an individual in one year is capped at £30k based on the market value of the shares. The exercise period of these options must be between three and ten years from the date of the grant.
When the share options are granted to the individual, the exercise price must be equal to or higher than the current market value of the shares, and the employee must not own more than 30% of the company to be eligible for participation in the scheme.
There is no tax or national insurance implications at the time of grant or exercise, and the gain on the shares will be calculated as proceeds less exercise price.
HMRC Manual ETASSUM 50000
The EMI scheme is widely regarded as the most tax efficient share option scheme available to companies. It is similar to the CSOP scheme, however is for smaller companies with gross assets less than £30m and less than 250 full time employees.
Again the company can choose who it offers the options to, although they must work at least 25 hours a week for the company in order to be eligible and again then cannot own more than 30% of the company.
There is a limit of granting up to £250k of options per employee and the total amount of options issued under this scheme cannot exceed £3m.
The exercise period for these shares must be 10 years or less following the date of grant, and these shares are eligible for entrepreneur’s relief which is calculated from the date of the grant and can be claimed even if the individual does not hold 5% of the shares in the company.
If the exercise price is at a discount from market value then at the date of grant the individual will be subject to income tax on the difference between the exercise price and market value. Additionally if the company is quoted then the individual will also need to pay Class 1 National Insurance on the shares as they are deemed to be readily convertible to cash.
Once the individual comes to sell their shares they will be taxed based on the proceeds less the market value at the time of the grant.
Non Tax Advantaged Scheme
Set out in ITEPA 2003 Part 7 Chapter 5
If an individual takes share options by any other means, then it will not be tax advantaged, and will be subject to the normal rules which are as follows:
Income tax is charged on the exercise of the non- tax-advantaged option on the difference between the market value of the shares at the date of exercise and the amount paid for the shares under the option. It is important to note that employees wishing to retain their shares rather than sell them immediately following exercise may experience cash flow problems in paying for the shares. This may encourage sales of shares by employees to enable them to pay the option price and/or their tax liabilities.
If the shares acquired are readily convertible to cash the company will be obliged to account for these income tax liabilities through the PAYE system. Both employee Class 1 (at 12%/2%) and Employers Class 1 NIC (at 13.8%) will also be due on exercise of the option where the shares acquired are readily convertible. However, it is possible for the option to be granted subject to the condition that the employee agrees to bear the employer’s NIC liability.
It is also worth noting that if the shares are not readily convertible to cash, then the tax will be payable via self assessment and there will be no charge to National Insurance, either for the employee or the employer.
Capital gains tax will only be applicable from the date the options are exercised. Therefore, if the options are exercised and sold immediately, the full gain arising will have been subject to income tax so no capital gains tax will be due. Alternatively, if the shares are retained after exercise any future growth in value will be subject to capital gains tax on disposal, calculated as the proceeds less the market value at date of exercise.
In addition to the above referenced HMRC Manuals and Legislation, Bloomsbury have also published a book “Employee Share Schemes” which is available online: https://www.bloomsburyprofessionalonline.com/view/employee-share-schemes/book.xml
Tax Advantaged Share Scheme Illustration
Say an employee is granted the option with an exercise price of £3 on 1 September 2018 (when the MV of the share is £3). They then exercise the option and buy one share on 31 March 2019 when the MV for the shares is £5. They then sell the share on 1 September 2019 when the MV has risen to £8.
|Tax Advantaged Scheme||Non-Tax Advantaged Scheme|
|Upon Grant||No tax impact||No tax impact|
|Upon Exercise||No tax impact||The employee suffers income tax as employment income on £5-£3 = £2|
If readily convertible then this is deducted via PAYE, and National Insurance will also be payable by the employee and the employer
|Upon Sale||A chargeable gain arises: £8-£3 = £5 subject to CGT||A chargeable gain arises of £8-£5 = £3 subject to CGT|
Eligibility Tables and Conditions
Share Option Scheme (CSOP)
You Earn (SAYE)
|Summary||Employer grants employees share options||Same as CSOP, but for smaller companies||Employees save a monthly amount|
(from net income) which exercise
options at end of scheme
|Income Tax||No IT at date of exercise||If grant was at a discount IT assessed on|
the amount of the grant vs market price
|No IT paid on interest earned during the period|
|NIC||No NIC at date of exercise||Class I NIC on the discount, if Co is quoted||No NIC paid on interest earned during the period|
|CGT on Sale||Gain = proceeds less exercise price||Gain = proceeds less MV at grant||Gain = proceeds less exercise price|
|Participation||Employer chooses, must be full time director or full/part time e’ee||Employer chooses, must work 25+ hours per week||All employees eligible, but can set minimum employment period|
|Max value||£30k in MV of shares per e’ee||£250k in MV of shares per e’ee, max of £3m for overall scheme||£500 or less saved from net pay per month|
|Exercise period||3-10 years after grant||10 or less years after grant||Scheme length 3/5 years|
|Issue price||MV or higher at grant||MV or higher at grant, discount is assessable to IT and NIC||Price agreed at start of scheme, can be up to 20% discount of MV at that date|
|Other||E’ee must own less than 30% of Co to participate||E’ee must own less than 30% of Co to participate|
Trading Co must have: Gross Assets < £30m + <250 Full time e’ees
Ent. relief period is from date of grant & can be less than 5%
Share Incentive Plan
|Income Tax and NIC||1. No IT or NIC if free and shares are held in plan/trust for at least 5 years|
2. IT (+ Class 1 NICs if quoted) on lower of value at grant and value at withdrawal if withdrawn within 3-5 years
3. IT (+ Class 1 NICs if quoted) on MV at withdrawal if withdrawn within 3 years of grant
|CGT on Sale of Shares||Gain = Proceeds less MV at withdrawal date|
Therefore if you sell on withdrawal date there is no CGT
|Other||Dividends received whilst in the plan are tax free if invested in more partnership shares. But dividends are taxable if shares are withdrawn within 3 years.|
|Max Value||Given free shares: max value £3.6k p.a.|
Buy partnership shares: £1.8k p.a. (deducted from gross salary, capped at 10% of salary)
Given matching shares: max of 2 per partnership share
|Holding period||5 years in order to avoid both IT and NIC|