Evidence suggests wider employee ownership offers benefits to employees, businesses and the wider economy, potentially delivering higher productivity and profitability. 

Employee Share Ownership Schemes (ESOS) allow some or all employees to acquire equity, but without the business owners losing control, to encourage employee shareholders to act like owners and share in future success.

Alternatively, business owners can exit their business by selling the majority of shares to an Employee Ownership Trust (EOT), transferring ownership to people they know, who share their passion for continued success.

Exploring Employee Ownership Trusts

The EOT encourages exiting owners to sell their business to their employees, with the transaction entirely free of Capital Gains Tax (CGT) and offering numerous advantages:

• No third-party negotiations makes for a simpler, quicker sale, with associated cost-savings.
• Minimal disruption to the business after the sale.
• Owners can exit according to their timescale.

The EOT trust becomes the majority shareholder, but delegates responsibility for running the business to the directors, which means little change to the management structure, unless changing the board was part of the owner’s succession strategy.  

Tax benefits enhance the appeal

Owners selling a controlling stake in their company to an EOT will receive 100% relief against CGT, regardless of the size of the business.

Employees of EOT-controlled companies can each receive income tax-free bonuses up to £3,600 annually, although National Insurance Contributions (NICs) still apply to such bonus payments.

Although there is usually an initial cash consideration, most of the funds are paid from the company’s profits. It will typically take 5 – 7 years for an owner to be fully paid. A detailed feasibility study will help owners identify a reasonable value for the business, based on future profits, to ascertain how much and when consideration might be paid.

Employee Share Ownership Schemes

There are various Employee Share Ownership Schemes (ESOS) available to owners of private and listed companies.

Enterprise Management Incentive (EMI)

EMI is a popular discretionary share option scheme aimed at smaller companies, providing a flexible, tax efficient way to reward all or selected employees, who can buy shares in the business in the future, at a price fixed at the date the options are granted.

Companies must be independent, undertake qualifying activities, have gross assets not exceeding £30m and employ fewer than 250 full-time equivalent individuals.

Each employee may be granted options over shares with a value of up to £250,000 at grant date, with a £3m company limit. There is usually no income tax or NICs on grant or exercise of EMI options (unless options are granted at a discount to market value).

Business Asset Disposal Relief (BADR) applies, for an effective tax rate of 10%, provided that at least two years has passed between the date options are granted and the date shares are sold.

EMI options may be granted over different share types, with any exercise price and any performance conditions. Options granted with an exercise price at less than market value, will result in a tax charge when the option is exercised.

Company Share Option Plan (CSOP)

For businesses that do not qualify for an EMI, the next best discretionary option scheme is the Company Share Option Plan (CSOP).

It is also a tax advantaged discretionary share option plan for all or a select few employees, but with a less generous option limit of £60,000 per employee. Options must be granted at the market value, not with a discounted exercise price.

The tax treatment is less valuable than for an EMI, with participants only able to exercise options tax efficiently three years or more after the grant date. Any growth in value is subject to CGT rather than income tax, but BADR does not automatically apply.

CSOP remains flexible, as performance targets can be attached and different share classes can be used. With no company option limit, CSOP is a good scheme for bigger businesses wishing to reward larger numbers of employees. 

Share Incentive Plan (SIP)

The Share Incentive Plan (SIP) is a good choice for businesses wanting to reward all employees, on an equitable basis, with maximum tax efficiency. Shares are held in a trust on behalf of employees and if held for five years, there is no tax to pay, whilst any increase in value will be entirely free of CGT.

Shares can be gifted, free of income tax and NIC to employees, who may also buy ‘partnership’ shares from pre-tax salary, either through monthly deductions or via a one-off payment (e.g., a bonus).  Buying shares may entitle them to receive two free ‘matching’ shares for each ‘partnership’ share bought. Dividends can be reinvested in shares, also on a tax efficient basis.

Employees can acquire shares worth up to £9,000 each year – £3,600 free shares, £1,800 partnership shares and £3,600 matching shares.

Save-as-You-Earn (SAYE)

SAYE is a tax advantaged all employee share option plan, with employees saving £5 to £500 each month into a linked savings account for three or five years, after which they can exercise the share options granted when they started saving, or simply take their savings. 

Options can be granted at a discount of up to 20% on the initial share price and employees may receive a tax-free bonus when they withdraw their savings.

Growth Share Plan (GSP)

Growth shares only deliver value once the company has reached a specified value. Employees can purchase growth shares more cheaply than full value ordinary shares, but still benefit from capital gains tax treatment on the sale of the shares.

Growth shares can ring-fence existing value for current shareholders and incentivise participants to grow business value.

Avoiding common pitfalls

Professional advice is recommended when setting up and running any share plan to ensure it meets its commercial objectives and tax benefits are retained.

Many private company owners protect their position by using, for example, non-voting shares in a share scheme, but should be clear about their objectives, the participants, how much equity to use, and how to deal with leavers.

Share plans must comply with legislation throughout their lifespan and care should be taken that corporate events don’t risk disqualifying the scheme, such as entering into a joint venture arrangement which may disqualify an EMI scheme.

Administering the plan correctly is critical, especially should the company be sold, when the share scheme will be subject to close scrutiny during the due diligence process.

Employee share plans must be registered with HMRC and annual returns submitted, with failure to do so, possibly resulting in fines, challenges during due diligence and in the worst-case scenario, disqualifying the plan from the numerous tax advantages.

John Dormer has worked for over 20 years with private company owners and plc Remuneration Committees, supporting them in the establishment and operation of employee share plans, focussed on working with stakeholders to understand their commercial objectives and designing share plan arrangements to align with those desired strategic goals. He has worked at large national law firms and as a lawyer within a “Big Four” reward practice.

The RM2 Partnership was formed in 1991 and became an employee-owned business in 2019, using the Employee Ownership Trust model. The RM2 team has been involved in the design of Share Incentive Plans (“SIP”) and Enterprise Management Incentives (“EMI”) legislation (and other government sponsored employee share plans) and in commenting on guidance, policy and market practice relating to employee share ownership.

Photo by Dylan Gillis on Unsplash.