Incentive Pay

3. Using Shares

Offering shares in your business is more complicated than offering cash. But share schemes can be much more effective in linking the interests of the business and the employees, as well as encouraging long-term commitment. Grants of shares through approved Employee Share Schemes will generally be free of tax and NICs (see below).

Any gains will be subject to capital gains tax (CGT), if they exceed the individual's annual exempt amount (£10,100 in 2010/11). There are two rates of CGT, 28 per cent for higher-rate income tax payers and 18 per cent for those paying the lower tax rate.

3.1 Offer senior executives or key employees the chance to participate in an approved share option scheme, for example the Company Share Option Plan (or CSOP).

• You give selected employees the right to buy shares at their current price, at a later date. If the shares increase in value in the meantime, they will make an immediate profit when they exercise their options.
• Each employee may hold options on shares worth up to £30,000.
• The option can be exercised after three years, but not later than ten years.
• Employees who own ten per cent or more of the company's shares cannot participate.

3.2 Small companies (gross assets not exceeding £30 million) can offer share options to employees through the enterprise management incentive scheme.

Companies can seek 'advance assurance' from HM Revenue & Customs (HMRC) that they meet the scheme's requirements.

• All employees can take part in this scheme, if the employer so chooses. The total value of shares under option must not exceed £3 million.
• The employees must spend substantial time working for the company. This means at least 25 hours a week or 75 per cent of working time.
• Provided the options are exercised within ten years, and at the market price when they were granted, employees do not pay income tax or NICs.
• The value of the shares under option must be agreed with HMRC when the grant is made.

3.3 Consider setting up a Sharesave scheme.

• All employees must be able to take part on similar terms.
• All members get the right - but not the obligation - to buy a number of shares, normally at a discount to their current price, after three, five or seven years.
• They save a regular amount with a bank or building society in the meantime, to pay for the shares. They can save £5 to £250 per month.
• If the shares rise in value, employees have a profit when they buy shares. If the shares fall in value, they ignore the option and take the savings instead.

3.4 Many companies set up non-approved share schemes, which are usually reserved for executives, senior managers and other key employees.

• There are no limits on the amounts that can be granted under such schemes.
• The shares count as business assets and currently qualify to be charged to CGT (see 3.5). But employees who receive benefits have to pay income tax on the full amount.
• Conditions are normally imposed. The idea is to ensure that the rest of the shareholders benefit as well.

3.5 There was a significant reform to the way CGT is calculated in 6 April 2008, and again in June 2010.

• Higher-rate income tax payers are liable to pay CGT at 28 per cent. For those paying the lower income tax rate, CGT is charged at a flat rate of 18 per cent.
• Taper relief and indexation allowance was withdrawn.
• Entrepreneurs' Relief was introduced, which reduces CGT on the first £5 million of qualifying gains.