Share incentive plans continue to be popular tools in aiding UK firms to entice and retain high flying executives. But advisers need to be switched-on if they are to ensure their top-earning clients wring maximum benefit from the incentives they are offered.
Basic HM Revenue and Customs (HMRC) approved share schemes such as sharesave – or Save As You Earn – and Share Incentive Plans (Sips) are particularly popular amongst UK companies for employees of all levels. But the savings limits set within these fall far short of providing an adequate incentive for top executives.
Other HMRC approved schemes go further, with Enterprise Management Incentives (EMI) one of the more popular and tax-efficient approved plans for executives. But EMIs have very strict qualifying criteria and options are limited to £100,000 per employee.
Less restrictive in terms of qualifying criteria is the Company Share Option Plan (CSOP), which also offers tax advantages. But the downside of these arrangements is that the benefits are even more limited, with options capped at £30,000 per individual.
The restrictions on approved schemes mean employers wanting to offer significant incentives to senior staff are having to top them up with unapproved schemes of one sort or another.
“We’re still seeing most companies going for an approved scheme at some point,” says Kiki Stannard, tax director at accountancy and financial services firm Smith & Williamson. But she says proportionally most of an executive’s share incentives will be unapproved.
Unapproved schemes give firms the freedom to tailor plans to their own needs, albeit without the tax benefits of approved schemes.
Arrangements include option plans which David Tuch, principal at Hewitt Associates says are generally exercised after three years, with a maximum life of 10 years.
Tuch says these option plans typically come with performance conditions – the most common of which are set around growth in the earnings per share. However, not all companies will put such targets in place.
Another way of setting up such arrangements is Performance Share Plans or Long-Term Incentive Plans (L-tips), he says. These award free shares to the executive – but again, they are only typically awarded in three years time and if performance conditions are met.
A variation on this is Restricted Share Plans, which, as Tuch explains, essentially work in the same way as L-tips with free shares awarded if the executive stays with the firm.
But there are no performance conditions attached and it normally vests over three or four years in equal instalments, so every year another quarter or third of the award vests, Tuch says.
The use of nil price options – where executives get shares for free – are growing in popularity, Stannard says. This is due to the fact it requires the company to give up less shares to transfer an equivalent gain to the executive, who benefits from the full value of the share, not just any increase in share price.
She is also seeing a trend towards employers deferring part of an executive’s bonus payment into shares.
“To make it a bit more of an incentive to have this, the value of your deferred bonus might also be enhanced by extra shares,” she says.
For unlisted firms, Stannard says share awards are generally more directed towards events such as a listing, or a sale, or to reward long service.
Mark Collins, regional employer consulting tax partner at Baker Tilly Tax and Advisory Services, says executives need to be mindful of the tax treatment for the particular schemes they are in. “They’re quite complicated things and they need to understand what they’ve been granted and how it’s taxed,” he says.
Tuch too stresses the need to be aware of the tax liability. For example, with unapproved option schemes, as soon as the option is exercised and a gain realised, tax is incurred, even if no shares have been sold, he says.
Most companies will operate provisions whereby employees can tick a box on the exercise form to ensure enough shares are sold to cover both the exercise price and the tax, Tuch says. But, he has seen situations where executives have exercised their options and then held on to the shares, only to be disappointed to find out that they owe more in tax than the shares are worth.
“A week later something’s happened and the share price has bombed. Suddenly the shares you’re left with are worth less than the tax charge you’ve got.”
Janet Cooper, global head of employee incentives at law firm Linklaters, says executives need to ensure the performance targets set are appropriate, deliverable and that the executive understands them.
“This is essential, because at the end of the day, if they don’t deliver on the performance, then it won’t deliver to them,” she says.
Those with options or shares in an unlisted firm also need to take care that there will be a market for those shares when they come to sell.
Stannard points out that leaving a company also has to be managed carefully. Each scheme will vary in how “good leavers” are treated as oppose to “bad leavers”, with bad leavers at risk of coming away with nothing unless the options have already vested.
From a wider financial planning perspective, diversification needs to be considered for executives receiving large chunks of shares in their employer.
As Bob Perkins, technical manager at Origen says: “If you’re not careful you end up with a lot of eggs in one basket, which is one of the issues with company share schemes.”
Tax planning opportunities with unapproved schemes are limited, but Cooper says some opportunities do exist, such as making use of a family benefit trust to defer when the tax liability is incurred.
However, most come with disadvantages for the employer.
“Therefore, they may be put in place for some of the very key people, but on the whole it’s not for executives generally,” she says.
As Stannard points out, because the employee decides exactly when they exercise their option after it has vested, there is a certain amount of planning opportunity there in terms of when they crystallise the profit and tax liability. Spreading crystallisation events into different tax years will mean more than one capital gains tax liability can be utilised.
There is also some opportunity for shares to be sacrificed into a pension, in order to benefit from tax relief, she says. “But more often than not, people will just have to pay their tax and be done with it,” she says.
Collins points out that executives should look to make use of any spousal capital gains tax exemptions that might be available to them where it is advantageous.
“In certain circumstances they can look to transfer shares into their wife or husband’s name and they could then both sell the shares,” he says.
While share incentive schemes can be very lucrative perks, advisers need to stay on their toes if they are to ensure their clients get the very best out of them.
Case study – EMI ‘The best scheme around’
“If the Revenue could deal with some of the issues around EMI, then actually you could have a much better scheme all-round”
Ian Griffiths, finance director, ANGLE
Surrey-based venture management firm ANGLE Plc creates and founds new technology ventures, making extensive use of share incentive schemes in order to attract and retain the key staff it needs for these start-ups.
“There are essentially three main routes we use,” says Ian Griffiths, finance director of ANGLE. “Restricted shares, unapproved share options and the HMRC approved Enterprise Management Incentives (EMI) scheme.”
Griffiths describes the EMI as “the best scheme around” combining the advantages of shares with those of options and offering business asset taper relief to reduce Capital Gains Tax from as soon as the shares are granted.
However, Griffiths believes the EMI is unnecessarily restrictive. Companies must be independent to qualify which causes problems for ANGLE when start-ups are still under its control.
The £100,000 cap on shares per person is also too restrictive for top staff, he says, as are the conditions around the amount of time the employee must work and the loss of tax relief incurred if they leave.
These restrictions mean ANGLE is often forced to make use of restricted shares and unapproved share option plans in place of, or as well as, EMI schemes within its new ventures.
Performance conditions are put in place to ensure the firm can claw back equity, for example if a new chief executive does not work out, or to help meet key targets, such as attracting third party funding, or achieving a successful product launch.
“The reality is you’ve got to use a combination of share incentive plans,” Griffiths says.
“But if the Revenue could deal with some of the issues around EMI, then actually you could have a much better scheme all-round that reflects the reality of life in small technology start-ups.”
Share schemes lose the incentive
New proposals announced in Chancellor Alastair Darling’s first Pre-Budget Report have potentially dulled the shine on share incentive schemes for some employees.
Currently those who sell shares they have received in their employing company – be it through approved or unapproved schemes – can claim business assets taper relief on their shares. This effectively brings the capital gains tax (CGT) rate down to 10 per cent for higher rate tax payers and 5 per cent for basic rate tax payers if they hold the shares for over two years. The Enterprise Management Incentives scheme is one of the most attractive in this regard, as taper relief can be applied from the time the share option is granted, rather than when the shares are actually received by the employee – as is the case with other schemes.
However, the Chancellor announced plans in the Pre-Budget Report to remove taper relief from April 6, 2008, replacing it instead with a standard CGT rate of 18 per cent.
While the overall effects vary depending on the share incentive scheme, in broad terms the change has no negative impact on those employees seeing capital gains of less than the current exemption level of £9,200 per year, or for those who choose to sell their shares within two years and pay the CGT bill, as is commonly the case. However, those with gains of more than £9,200 and holding on to their shares for more than two years will find their CGT bill is greater than before the change.
Mike Landon, principal at Mercer, says: “It’s likely to be more senior people with more substantial share awards who will be affected by this than the ordinary employee participating in an approved all employee scheme.”