When a company is considering share-based incentives for employees, it is key to take appropriate advice and determine an effective plan. An effective plan must consider both the commercial design and the tax treatment of the structure. Although many consider the tax structure as the most important feature of any share plan, the tax efficiency should be less important than the commercial purpose of the plan.
Purpose of the incentive plan?
Consider what is the main purpose of the plan and what is the company looking to achieve:
- Recruit and retain staff
- Incentivise staff
- Enforce good/positive behaviours
- Reward performance
- Support the culture of the company
- Enforce the structure of the company and employee based ownership
- Performance based or only exercisable upon an exit event
Once a company has considered the above and determined the main purpose(s) of the plan, then advisors can look at tax structures which best suit what a company is looking to achieve.
The purpose of a plan will differ from company to company and, in light of COVID, an existing plan or a proposed plan may not have the same commercial impact. For example, due to the labour market in the COVID crisis, the recruitment and retention of staff may be less important, but incentivising the right behaviours in staff may be more important. So existing plans should be reviewed, in addition to these considerations given to proposed plans.
Different types of plans
- EMI Schemes
These are one of the most popular share-based incentive plans and are often the best approach. They are very flexible and very tax efficient. However, they are not available to all companies, due to the qualifying criteria, which we look at briefly later in this blog. These are a HMRC plan.
These are alternative HMRC plans. They are less flexible than EMI but still provide capital gains opportunities and income tax reliefs.
- “Geared Growth” Arrangements
These refer to growth shares and similar arrangements introduced more recently by HMRC. They allow for income tax to be chargeable at the outset (if elections are made), then capital gains tax if performance is high (so valuation is key). These are more complex, but gaining popularity in private limited companies.
If HMRC schemes are not available or not suitable, a company can still look to put in place income-taxed arrangements including non-tax advantaged options, phantom options, etc. These are much more flexible arrangements as a company does not have to meet any qualifying criteria or seek elections/approval from HMRC. They are, by their nature, less tax-advantaged than the HRMC schemes detailed above. Income tax will be charged when an individual makes a gain.
Effects of COVID when considering Share-based Incentives
For many companies, share values will now be lower and there may be changes in business strategies, for example, there may be more focus on short to medium-term plans rather than long-term strategies. Many companies will have reduced workforces. There may be cash constraints on the company. All these things will require consideration before determining the best options for a company.
The Chancellor, Rishi Sunak, announced in July that there will be a review of capital gains tax and this may have the effect of reducing the tax benefit of some/all incentive arrangements, so we will need to await the outcome of this review.
This emphasises the importance of getting the commercial structure right, so the incentive gives the best available tax outcome, even if tax benefits change.
Effects of COVID on EMI Schemes
In terms of EMI schemes, which are one of the most popular type of share-based incentives schemes, the qualifying criteria for companies is briefly as follows:
- £30m gross asset limit; and
- 250 employee limit
It may be that due to COVID, a company’s gross asset value has reduced and/or the employee numbers may be lower due to a reduced workforce. So a company which may not have qualified for EMI previously, may now qualify.
Concerns have been raised about disqualifying events under EMI and whether individuals on furlough or whose hours have been greatly reduced could be disqualified. However, HMRC have confirmed that these risks will not affect qualification if due to COVID.
If you would like more information or if you have any questions or queries relating to the above, please contact Rachel Owen from our Commercial and Commercial team on 0161 926 1579 or email@example.com to receive expert legal advice for your business.