It’s often best to start with the conclusion, so let’s do that here. For UK business owners and leaders, employee share plans are a great way to offset costs and reward employees efficiently. For employees participating in share plans, they can expect to pay lower (often significantly lower) rates of tax than they would compare to ordinary income.
The fact is for decades the UK government (and many governments around the world) have been trying to encourage employee ownership and have given tax breaks to incentivise the market. The evidence is there that it makes businesses more financially sustainable, and helps the ordinary worker thrive. The tax man may see less money directly, but that money goes into people’s pockets, where it’s then spent.
Share plans are an economic win-win.
The difficulty often comes with communicating that fact. Talking about tax breaks in the future and offsetting costs are not as glamourous as the year-end bonus or the big annual paycheque.
So, for companies looking to increase participation in their employee share plans it’s a must to understand the general principles around tax and equity compensation, and how they can benefit your bottom line and your employees’ bank balance.
In this article, we’re going to look at the issue from the perspective of the business owner, the people who run the business day-to-day, and the employees themselves.
Skip to the relevant section below;
- Tax advantages of employee share plans for UK owners
- Tax advantages of employee share plans for UK employers
- Tax advantages of employee share plans for UK employees
- How UK employees are taxed under different share plans
- Is it worth joining a UK employee share plan for the tax benefits alone?
Tax advantages of employee share plans for UK owners
The UK gives generous tax breaks to business owners selling shares in their company
Let’s start from the very beginning – with the owners of a company. In the UK, since 2014, owners who sell a majority interest in their business to an employee-owned structure, such as a trust, will receive capital gains tax relief.
In other words, you’re encouraged from the very beginning of a business’s lifecycle to implement employee ownership.
Beyond this, business owners can receive benefits in similar ways to the ones their employees receive when it comes to sharing plans, but they are also subject to more stringent rules than a normal employee when selling shares in their own business.
Tax advantages of employee share plans for UK employers
Most of you reading this won’t be owners of the business you work for, but you will be concerned with its financial health. You’ll be glad to hear then that there’s plenty of evidence that being an employee-owned company will make it more financially sustainable, but where are the direct financial benefits?
HM Revenue and Customs (HMRC) offer tax benefits to employers under ‘approved’ or ‘statutory’ schemes. ‘Unapproved’ schemes, while giving a company more flexibility in what they can offer their talent, typically do not come with the same tax benefits as approved ones.
There are currently four HMRC approved share option schemes available (all these options have criteria that a company must meet before being eligible to implement them). These are:
- Share Incentive Plan (SIP)
- Save as you Earn (SAYE)
- Company Share Option Plan (CSOP)
- Enterprise Management Incentive (EMI)
The tax breaks for the SIP and SAYE schemes are quite simple – corporation tax relief can be obtained by the company for the cost of setting up and administering one of these schemes.
With CSOPs, the UK employing company will generally qualify for a corporation tax deduction equal to the spread (the difference between the market value of the option shares on the date of exercise and the exercise price) for the accounting period in which the option is exercised.
With EMIs, the employer company may be able to claim corporation tax relief on the option gain (the difference between the initial share offering and the final price at vesting time).
Most of the tax breaks for companies when it comes to employee share plans are offsetting the cost of setting them up, smoothing that initial leap, and also covering any movements in the market in the period the share plan is running. These tax benefits limit, but do not entirely remove, the risk of employee ownerships and market movements.
Tax advantages of employee share plans for UK employees
The real tax benefits of UK employee share schemes are aimed at ordinary participants
Here’s the fun part – how ordinary people can use employee share plans to increase their bank balance. We’ll take the same structure as we did before; looking at the HMRC approved schemes and where the tax benefits are within each. There is crossover on many of them.
But first, let’s look at all the places an employee could be taxed, and when.
These are three moments in the UK when tax can be applied to recipients of share awards:
- On award (only affects ordinary shares)
- On exercise (only affects options)
- On sale (always due on all shares)
At these moments, two different types of tax can be applied:
Capital Gains Tax
A participant will normally pay somewhere between 10-20% Capital Gains Tax when selling the shares. The Capital Gains is applied to the gain in the value of the shares from the point they were first given to the point they were sold. In the case of share options, any gain in value will be paid of exercise.
There are a number of ways you can avoid or defer paying Capital Gains Tax – explained in the sections below.
Usually, between 20 – 45%, this is due when the options are exercised or, sometimes, at the point of sale. The rate of tax will be calculated based on the recipient’s current tax rate.
How UK employees are taxed under different share plans
There are a number of different types of UK share plans, and each is taxed differently too
Now we know when and how we will be taxed, let’s look specifically at different types of share plans and how they are taxed in the UK.
Share Incentive Plans (SIPs)
In a SIP, an employee makes monthly deductions from their paycheque of a fixed amount they choose. The company then uses those monthly deductions to purchase shares for the participant. SIPs generally last for five years and differ from an SAYE in that you cannot withdraw the cash savings like you do in an SAYE but must take the shares.
There are significant tax and National Insurance Contribution (NIC) benefits of being in an SIP scheme, such as:
- If you get shares through a Share Incentive Plan (SIP) and keep them in the plan for 5 years you will not pay Income Tax or National Insurance on their value.
- You will not pay Capital Gains Tax on shares you sell if you keep them in the plan. If you take them out of the plan, keep them and then sell them later on, you might have to pay Capital Gains Tax if their value has increased.
- A SIP scheme can also allow participants to buy a limited number of ‘partnership’ shares on an annual basis. Partnership shares can be bought from pre-tax salary.
If the scheme allows it, employees may also be able to buy more shares with the dividends they get from free, partnership or matching shares. You do not pay income tax on these dividend shares if you keep them for at least three years.
Save as you Earn (SAYE)
Save as you Earn (SAYE) – sometimes known as ‘ShareSave’ schemes in the UK – allow for employees to save a portion (up to £500) of their monthly income to buy shares at a fixed price. The schemes usually last 3 or 5 years.
Again, the tax advantages for employees in SAYE schemes are significant, particularly when you compare them to income tax rates. Notable advantages include:
- You do not pay income tax or national insurance on the difference between what you pay for the shares and what they’re worth
- The interest and any bonus at the end of the scheme is tax-free
You may be liable to Capital Gains Tax when you sell the shares, depending on whether you made a profit on them.
However, even here, you can avoid paying Capital Gains Tax by either 1) transferring your shares to an Individual Savings Account (ISA) within 90 days of the scheme ending or 2) transferring the returns to a pension directly when the scheme ends (or within 90 days, but you may have to pay Capital Gains if they go up in value during that period).
As you can see, SAYE schemes are an ideal way for people to build up their investment portfolio in a cost-efficient way.
Company Share Option Plan (CSOP)
A Company Share Option Plan (CSOP) gives a participant the option to buy up to £30,000 worth of shares at a fixed price.
With a CSOP, you do not have to pay Income Tax or National Insurance contribution on the difference between what you pay for the shares and what they’re actually worth – something very common as a company will often offer the shares at a discounted price.
If the value of the shares does go up, you may be liable to Capital Gains Tax if you sell them. There is a Capital Gains Tax exemption of £12,300 (as of 2020/21) and above that gains are subject to the top rate of 20% (or 10% if the person is on a lower income than £50,000 per annum).
Enterprise Management Incentive (EMI)
EMIs are really aimed at smaller (but still substantial) companies with growth potential. There are a number of qualifying conditions to being able to implement an EMI, such as the company having assets of £30 million or less and not offering more than £250,000 in shares to any individual, but once they meet them there are generous tax advantages to be had.
- A participant won’t pay any income tax or national insurance if they buy the shares for at least the market value they had when granted the option.
- For any discount on the market value, a participant would have to pay income tax or national insurance on the difference between what they paid for the shares and what they’re worth.
- You may have to pay Capital Gains if you sell the shares.
EMIs are often used to attract top talent to growing companies. While they may not be able to offer the salaries the big corporations can offer, having an EMI scheme in place can offset that difference and indeed make it more profitable for an individual to join the company.
Is it worth joining a UK employee share plan for the tax benefits alone?
When you’re asked the question ‘what do you earn?’ it’s natural for your mind to go straight to your annual pay, and then we’re all sophisticated enough to add in rough bonus calculations on top of that.
What we’re not great at, though, is realising that sometimes taking homeless each month through investing in shares will pay off significantly in the future. The human brain is hugely risk-averse and usually prefers something guaranteed today to a big promise tomorrow.
The truth is, it’s the people that make a conscious effort to diversify their income (and have the means to do so) and take advantage of the tax breaks on offer that will end up financially more healthy. For businesses, it’s a win-win to have happy employees who feel they’re rewarded for their work and also take advantage of those tax breaks aimed at you.
The UK has long encouraged employee ownership through concrete, financial benefits; it’s up to all of us to take advantage of them.
If you want to explore how to make your UK employee share plan tax-efficient for both your company and your employees, get in touch with our experts.