TT294: Share Incentives

For small businesses attracting and retaining staff is often difficult especially when competing with large corporates who offer attractive benefits such as share schemes. Share incentives are an area often overlooked by smaller firms given that there is usually no traded market for the businesses’ shares. One of the advantages of share schemes, for both the company and the recipient, is to make use of capital tax rates which are generally lower than income tax rates.  

Employee share schemes are broadly split into ‘approved’ and ‘unapproved’ schemes, referring to whether they are recognised by HMRC. For several reasons, including the flexibility of selecting employees, the most appropriate approved scheme for small business is usually an Enterprise Management Incentive “EMI” scheme.

With an EMI scheme, the employee will typically have no income tax or national insurance liability on grant and exercise of the option. Instead, the employee is taxed to capital gains tax on the growth in the value of the shares up to the sale.

Assuming the shares are held by the employee for 2 years, including the period the option is held, then the EMI shares will generally qualify for Entrepreneurs Relief and a capital gains tax rate of 10% for the employee.

The directors need to be mindful of the initial qualifying conditions of the scheme as well as the type of events that may later disqualify them. If the qualifying conditions for EMI are breached, for instance, if there are more than 250 employees, then there is always the alternative to explore the unapproved schemes.

However, the introduction of this type of scheme means the recipient is usually taxed to a higher income tax rate (relative to capital gains tax rates) at the time the share is issued.

One solution is to give the employee a “growth share” which has a capital hurdle meaning that the share has a depressed value on the issue. Growth shares can also be used in conjunction with an EMI scheme, as they have some useful traits for the existing shareholders in that you are not giving away past value.

Growth shares, therefore, work very well for an owner-director who has built value, which they don’t want to give away, but where they are looking for new managers to drive the business forward, attracted by a substantial percentage of future growth.

If you want to create a share scheme for retention, reward or incentivisation there is a myriad of different options available to make the scheme work for your business.

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