How Employee Share Schemes Work
An employee share scheme allows employees or directors of the company to acquire shares in the company. You may select from four HM Revenue & Customs-approved share schemes (including EMI, CSOP, SIP and SAYE) entailing tax and National Insurance Contribution relief for the scheme and any number of unapproved schemes (not entitled to tax relief).
The general rule with an HM Revenue & Customs-approved scheme is that the grant of shares or an option to acquire shares is not treated as an income receipt by the employee and there is no tax to pay. On the eventual sale of the shares, there will be, however, a potential charge to capital gains tax. However, under a share incentive plan (SIP) there is no Capital Gains Tax provided the employee sells their shares as soon as they are removed from the plan.
With an unapproved share scheme, the employee will have to pay tax when he receives the shares on the difference between the amount paid for the shares by the employee and their current commercial value. This treatment also applies to an unapproved share option scheme if the option is capable of exercise more than seven years from its date of grant.
The growth in value of the shares following their acquisition may in certain circumstances also be subject to income tax (even where the shares were acquired for their market value). These tax liabilities apply whether or not the employee has actually sold or otherwise disposed of the shares.
The advantage of any employee share scheme is that it identifies the interests of employee participants with those of a company on a long-term basis providing an incentive to greater achievement. They also generally result in a net inflow of funds to the company without exposing the employees to a high level of risk, especially in the case of a share option scheme.
There are however certain disadvantages:
1. Issuing shares to employees dilutes the value of the other issued shares;
2. Employees who own shares can be troublesome if they become disaffected;
3. Articles of Association must contain a power for the directors to issue shares to employees without invoking existing shareholders' pre-emption rights;
4. The effect on morale and retention if the share price falls - particularly for share option schemes;
5. Administration costs of running the scheme.
With an approved scheme, HMRC will take some weeks to grant approval. A public company must call a shareholders' meeting giving at least fourteen days notice to pass resolutions to adopt the scheme. In addition, some time must be allowed for the drafting of scheme documentation and the approval of these documents by the board of directors.
In relation to unapproved schemes, a similar time scale will apply except, that HMRC approval will not be applicable. In the case of a listed company, the Stock Exchange and investment protection committees (representing institutional investors) publish guidelines on share schemes for employees.