Enterprise Management Incentive (EMI) Schemes can be used to incentivise senior employees as part of an employee owned structure. In this article  we explore how Share Incentive Plans (SIPs) can have a powerful and positive impact on incentivising and engaging employees in their business.

Why Employee Ownership?

Employee ownership is a flexible succession solution that enables businesses to remain successful beyond the retirement of the original business owners. Ownership succession of the business is usually secured by transferring at least the majority of the shares in the company to an employee ownership trust (EOT) and the business legacy is continued by the people who know the business best: its employees.

Beyond the use of an EOT, the employee ownership model can be tailored around the needs of individual companies, the exiting owners and their employees. Direct share ownership can play an important role in engaging employees in the new employee owned structure.

Direct share ownership can be particularly relevant when a business is first sold to an Employee Ownership Trust. It is often the case that the debt to pay to the former owners means that it will be many years before the employees receive any meaningful profit share. Having shares that are increasing in value over the repayment period can help reward and incentivise employees during that period.

Why a SIP?

A SIP is suited to a company that wants to encourage wide share ownership throughout its employees.

A SIP enables employees to buy shares from pre-tax salary and enables a company to gift shares to employees free from income tax.

If a company gifted shares to employees outside a SIP, income tax and, potentially, NICs would be chargeable on the value of the shares.

If shares that have been held in a SIP are sold and they have been held in the SIP for at least five years, there is no capital gains tax (CGT) payable on any gain.  In certain circumstances, shares that have been held for less than five years in the SIP may also qualify for CGT relief.

A SIP is an all employee share plan; it must be offered to all employees (with some optional exceptions for employees with limited length of service).

The company will also often get corporation tax relief on the value of the shares awarded through the SIP.

How a SIP works

A SIP is an all employee share plan.

The SIP legislation provides for four main types of plan shares to be used.  They are:

• Free Shares: Employers can give each employee free shares worth up to £3,600 each tax year.  The level of award can be varied based on objective criteria such as salary levels, hours worked or years of service.
• Partnership Shares: Employees can purchase up to £1,800 (or 10% of salary if earning less than £18,000 per year) of shares each tax year out of pre-tax and pre-NICs salary.  This can be a single one-off purchase or employees can save monthly contributions over a special accumulation / savings period.
• Matching Shares: Employers can give matching shares at a ratio of up to two matching shares for each partnership share purchased by the employee.  The ratio can be linked to certain criteria (such as the profitability of the company).
• Dividend Shares: Dividends paid on SIP shares can be used to purchase additional shares in the SIP.

You do not need to offer all (or indeed any) of these types of shares through the SIP and you can vary the types of shares offered year by year.

Employers can also use other optional features, such as Forfeiture (employers can make employees give up some or all of their free or matching shares if they leave for certain reasons within three years of receiving the shares) and Holding Periods (employers can require employees to hold free and matching shares in the SIP for up to five years).

Income Tax and NICS for SIPs

No income tax or NICs are chargeable on Free Shares or Matching Shares awarded to employees, so long as they are held in the SIP for at least five years.

If Free Shares, Matching Shares or Partnership Shares leave the SIP (e.g. because the shareholder ceases to be an employee) within five years, income tax (and potentially NICs) are chargeable as follows:

• if the shares have been held for less than three years, income tax (and potentially NICs) is chargeable on the market value of the shares when they drop out of the SIP; or
• if the shares have been held for between three and five years, income tax (and potentially NICs) is chargeable on the lower of the market value of the shares when they cease to be part of the SIP and the market value of the shares when they were acquired by the employee.

There is an exception if the shares cease to be part of the SIP because the shareholder has ceased to be an employee for certain specific reasons.  These include retirement, redundancy and death.  No income tax is payable in these circumstances.

Capital gains tax and SIPs

So long as the shares have been held in the SIP for at least five years, no CGT will be payable when the shares are sold.

In addition, if there is a general offer to purchase 100% of the shares in the company, any shares in the SIP that have been held for less than five years can also be sold free from CGT.

Corporation tax and SIPs

The company should be able to claim a corporation tax deduction when Free Shares and Matching Shares are awarded. The deductible amount should be the market value of the shares on the award date.

Qualifying criteria for SIPs

There are some qualifying criteria that need to be met before a SIP can put in place:

• The company must be independent; it cannot be a subsidiary of another company. But it can be owned by an Employee Ownership Trust.
• All employees must be eligible to participate in any award of shares through the SIP, subject to any qualifying period set by the company (see below).

The company may set a qualifying period of employment that employees need to meet before they can participate in the SIP:

• For Free Shares, this can be up to 18 months.
• For Partnership Shares and Matching Shares with no savings / accumulation, this can be to 18 months leading up to the date that the shares are acquired.
• For Partnership and Matching Shares with a savings / accumulation period, this can be up to six months before the start of the accumulation period.

SIPs can be a powerful element in a bespoke employee owned succession solution. The flexibility of the employee ownership model means that tailored succession plans can be created to meet the needs of most businesses, in most sectors if one of the owners’ succession objectives is to ensure that the business continues to be sustainable in the future.