Employee incentive schemes are an effective method for keeping employees motivated. It ties into the value-based business idea – by adding value to a business as an employee, the employee can expect a return on their effort. Some schemes also offer tax advantages to the employee and employer that mitigate the tax consequences that ordinarily arise when shares in the company are given to the employee.
It is important, however, to ensure you have a good understanding of the various employee incentive schemes available, in order to select the right one for your business.
First let’s consider the benefits of introducing a share scheme:
- attract new talent to work for your business
- offer an incentive to retain valuable staff across the business
- provide targeted incentives to selected employees
- conserve cash and reduce the cost of pay and/or bonuses
Employees can be given shares that are held in a trust, receive share options or purchase shares on attractive terms.
What are employee incentive schemes?
Employee incentive schemes are supplements to employees’ base pay that are intended to motivate employees to contribute to the company’s goals.
Employee incentive schemes take many forms but can be very broadly divided into: short-term and long-term or, alternatively, into tax-advantaged and non-tax advantaged schemes.
Short-term incentive schemes are designed to motivate employees to reach performance targets with a task or project. The business awards these incentive schemes throughout the year. E.g. Employers or managers implement recognition schemes to recognise employees’ efforts by providing monetary or non-monetary rewards.
Long-term incentive plans might range from two to five years. These are typically implemented to improve employee loyalty. Retirement plans and share options are two examples. E.g. Professional development schemes exist to encourage employees to stay with the business long term.
These schemes will help employees to advance in their professional roles and seek internal promotions.
Financial and non-financial incentives can be used in both short and long-term schemes.
Tax Advantaged schemes are approved by HM Revenue and Customs (HMRC) and provide tax benefits to both employers and employees. Each form of tax-advantaged (also known as ‘authorised’ or ‘statutory’) scheme has its own set of criteria.
Non-tax advantaged schemes differ from tax-advantaged arrangements in that HMRC does not need to approve their usage.
Employee share scheme
An employee share scheme can assist a business’s owners in transferring ownership to those who work in the business, such as family, or in facilitating a management buy-out. You can sell your business gradually while receiving tax benefits. The tax benefits available varies according to the share scheme. For example, deferred capital gains tax on the selling of shares through an HMRC-approved share incentive scheme.
There may be several advantages to establishing an employee share scheme for your business. However, you should be informed of some potential risks before making any decisions.
Advantages for employers:
Employers may benefit from establishing an employee share scheme in the following ways:
- encourage your employees to be more productive
- it helps to align the interests of employees and shareholders
- attracts new talent and/or retains key employees
- compensates for lower salaries and alleviates cashflow pressure
- improves employee loyalty and reducing employee turnover by remunerating employees in a tax-efficient manner
- increases working capital
- increases working capital
Disadvantages to employers:
The following are some of the potential risks of having such an employee share scheme:
- Share price volatility – the impact on morale and retention when the share price declines, especially for share option schemes.
- Administration costs include the short-term costs of developing and obtaining approval for a share scheme, as well as the long-term costs of managing the scheme and maintaining records.
- Dilution of share ownership – as more shares are issued, each share you own represents a decreasing percentage of the business, and you may lose control of the business. If you wish to continue making all crucial business decisions, you must hold 75% of the voting shares.
- Financial expectations – the risk of creating unreasonable expectations of financial rewards in employees.
- If employees want to sell their shares in an unlisted business (one that does not have shares on a public stock exchange), you may need to set up an internal market for the shares, possibly through the creation of an employee benefit trust.
a) Share-option schemes
Employees are usually rewarded through share-option schemes.
A share option is the right to purchase a specific number of shares at a fixed price at some point in the future within a corporation.
Employees can generally exercise their share options – that is, acquire the stock – after a certain length of time, known as the ‘vesting period’. You can condition the issuance and exercise of share options on meeting specified goals, such as specific sales targets.
When an employee exercises their share options, they do so at the price set at the time of grant, i.e. when the options were given to the employee, regardless of the market price at the time. They can then keep the shares or sell them for a profit if the market price is greater.
From a tax perspective, a share option is excluded from the definition of “employment related securities” under Part 7 of ITEPA 2003, making them not subject to taxation at the time of grant unlike shares which are subject to tax (in two possible ways, each having different tax consequences for the employer and employee).
b) Share-award schemes
Employees are given actual shares rather than share options, either for free or for a fraction of their market value, under share-award schemes. Unless you choose an HMRC-approved share scheme with specified rules and conditions, the value of shares distributed to employees is recognised as employment income and is liable to tax and National Insurance contributions.
c) Share-purchase schemes
Employees can use share-purchase plans to:
- buy shares
- save money to buy shares
- Buy shares with a small deposit and pay the balance later.
- When choosing to offer shares, you can select from a variety of different types with varying rights.
When it comes to tax, when you award share incentive schemes, no income tax or NIC is payable. Employees must pay income tax and national insurance if they leave the scheme before the three-year period is up. No tax or NICs are due if they keep them in the scheme for five years (three for dividend shares). The shares can be sold within the plan without incurring capital gains tax. Any shares removed from the scheme and later sold will be subject to CGT.
Leavers must withdraw their shares from the scheme. Good leavers will not be required to pay tax or NICs.
Save as your earn (SAYE)
You can provide your employees and directors options to buy shares at a predetermined price under SAYE. This is often the value of the shares less a 20% discount. The scheme will typically run three to five years.
Your employees will deposit up to £500 per month from their income into a special interest-bearing account, which they will use to buy shares if they want. This fund is guaranteed by the government’s financial compensation scheme.
Regarding tax, you can specify that only employees with a minimum time of employment are eligible, and allow all individuals who meet that requirement, to join on the same terms.
Employees will pay capital gains tax on any profit they make on the sale of their shares. The market price when exercised is used to calculate CGT. When the options are exercised, no income tax or national insurance contributions are owed, provided the exercise price is not lower than the share price at the time of grant.
Enterprise Management Incentives (EMI)
The EMI, or Enterprise Management Incentive, is a share option scheme supported by HMRC in the UK. It’s intended for employees or directors who work more than 25 hours per week or more than 75% of their working hours. In addition, it is designed to assist small businesses by making equity grants easier and more appealing as a tool for attracting and incentivizing employees.
When it comes to granting options to your employees, the EMI option scheme is the most tax-efficient method.
When it comes to EMI, your business is eligible for a Corporation Tax (CT) deduction in the amount that is equal to the difference between the market value of the shares at the time of the exercise and the price that the employee paid for them.
However, the advantages for your business go far beyond only reducing your liability for Corporation Tax.
Understanding your business
Choosing the right employee incentive scheme for your business can be a challenging task as it requires an understanding of your business’s goals, culture, and employee needs.
Here are some steps to help you choose the right employee incentive scheme:
- Identify your goals: Identify your business’s goals, whether it is to increase productivity, employee engagement, or retention
- Know your employees: Understand the needs and preferences of your employees. Conduct surveys or focus groups to determine what motivates them.
- Research incentive schemes: Each scheme has its advantages and disadvantages, so it is essential to evaluate them thoroughly.
- Consider the cost: Your business’s budget will determine the type of incentive that can be offered to your employees.
- Assess your business culture: The incentive scheme must align with your business culture. For example, if your business values teamwork, then an individual-based incentive scheme may not be the best fit.
- Test and Evaluate: Once you have chosen an incentive scheme, test it on a small scale to see how it works in practice. Evaluate the results and make changes if necessary.
Choosing the right employee incentive scheme requires careful consideration and understanding of the company’s goals, employees, and culture. It is imperative that you choose a scheme that is fair, transparent, and aligns with the company’s values.
It is also essential to have any employee incentive schemes designed and implemented, correctly, from the outset, in order to get the best benefits, so consulting with a legal advisor early on, is always recommended.
We have an experienced team of legal professionals at Redfern that can help with all areas of creating and implementing an employee incentive scheme.
To get started, please get in touch with us at email@example.com
The information in this article has been issued in the United Kingdom and is provided solely for informational purposes. Accordingly, whilst this article will be helpful to you when considering the subject matter herein, it does not constitute legal or any other form of advice and must not be relied on as such. It does not provide all the information you may need for effective decision making concerning your business. It is your responsibility to review and conduct your own due diligence on the relevant legislation and rules. You may wish to appoint your own professional advisors to assist you with this. All information in this document is subject to change without notice.
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