Evidence suggests wider employee ownership offers benefits to employees, businesses and the wider economy, including the potential for higher productivity and profitability, and also helps businesses retain skilled people and recruit new talent, says John Dormer.

EVIDENCE suggests wider employee ownership offers benefits to employees, businesses and the wider economy, including the potential for higher productivity and profitability, and also helps businesses retain skilled people and recruit new talent.

Employee share ownership schemes (ESOS) allow employees to acquire equity in the business, often very tax efficiently, which should encourage them to think about the long-term performance of the business as they will share in the rewards of success.

Alternatively, employee ownership can be an excellent exit route for owners. Selling the majority of shares to an employee ownership trust (EOT) ensures the business is sold to people they know and trust, who share their passion to deliver success.

Employee ownership trusts (EOT)
The EOT is designed to encourage owners who wish to exit their business to sell it to their employees, rather than a third party they do not know, or have competed against all their lives, which can be a difficult choice for many owners.

A sale to an EOT is entirely free of capital gains tax (CGT) and can be a compelling choice for business owners, allowing them to exit to their timetable with minimum disruption to the business during and after the sale process.

The absence of third-party negotiations also makes for a simpler and more cost-effective sale. However, most of the funds are paid over a period of time out of the company’s profits and exiting owners may typically have to wait five to six years to be fully paid.

The EOT trust becomes the majority shareholder, but delegates responsibility for running the business to the directors, ensuring little change to the management structure, unless specified by the owner prior to the sale as part of the succession strategy.

Each employee of an EOT-controlled business can receive income tax-free bonuses up to £3,600 annually, but national insurance contributions (NICs) will apply.

Employee share ownership schemes
There are various employee share ownership schemes (ESOS) available to business owners, offering a range of different benefits and tax advantages that can be used to deliver the future objectives of the business, whilst rewarding some or all of employees.

The following descriptions outline the general principles of the three most popular schemes. Each scheme delivers tax advantages, and owners should seek further advice on the tax treatment, which can be complex, before selecting the scheme that is best for their business.

Enterprise management incentive (EMI) A popular discretionary share option scheme for smaller companies, that provides a tax efficient and flexible way to reward some or all employees, by offering them the opportunity to buy shares in the business in the future at a price fixed when the offer is made.

The company must be independent, have gross assets not exceeding £30m and employ fewer than 250 people. Each employee may be granted options over shares with a value of up to £250,000 at grant date, with the overall company limit set at £3m.

EMI options may be granted over different share types, with any exercise price and with any performance conditions. Options can be exercised at any time after grant, but will usually lapse 10 years after grant.

Options are free of income tax and national insurance contributions (NICs), and gains are typically subject to capital gains tax (CGT) which is levied at 10% because of the application of business assets disposal relief (BADR).

Company share option plan (CSOP) For bigger or non-EMI qualifying businesses, the company share option plan (CSOP), is another tax advantaged discretionary share option plan. It can be made available to all employees, or to a selected few, performance targets can be attached and different share classes can be used.

The individual option limit of £60,000 is less generous than EMI and options must be granted at market value. The tax treatment is similar, although participants may only exercise options tax efficiently three or more years after the grant date, and BADR doesn’t apply.

Share incentive plan (SIP)
This equitable, all employee share plan provides a potential zero tax rate, with no income tax, no NICs, and no CGT.

Shares can be gifted, free of income tax and NICs, to employees, who may also buy ‘partnership’ shares out of their pre-tax salary, which may entitle them to receive a further two free ‘matching’ shares for each ‘partnership’ share bought.

Common pitfalls
Professional advice is essential to ensure the plan meets its commercial objectives and retains its tax beneficial status, at set up and during the plan’s lifetime. Business owners will need to identify participants, consider how much equity to use and think about how to deal with leavers.

Employee share plans must be legislatively compliant at all times and HMRC registration and annual returns are required. Failure to comply may result in fines or risk loss of the tax advantages.
www.rm2.co.uk
John Dormer is share incentives director at The RM2 Partnership