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TaxationWeb by James Darmon BA ACA

National Insurance increases announced in Budget 2002 are likely to make NIC efficient share schemes much more popular with company employees. James Darmon BA, ACA, associate at Forbes Dawson, discusses the impact of the Budget on Revenue approved share schemesNational insurance increases in the Budget have focussed attention on ways to reward employees without the need to pay income tax and national insurance.

One of the few remaining havens is to provide employees with shares under a Revenue approved employee share scheme. There are currently three main types of approved share scheme, the Share Incentive Plan (SIP), Approved Share Option Scheme (ASOP) and Enterprise Management Incentive (EMI) Scheme.

The potential benefits of these are:

- There is normally no tax or NI on the award of the shares.
- Rewarding employees by way of dividend, rather than bonuses. There is no NI on dividends. In addition, many employees will pay no further tax on dividends.
- The long-term potential to share in the company’s success, through capital gains. In many cases, taper relief and the annual CGT exemption will mean that employees pay no CGT on selling their shares.
- The ability to tie in employees for the long term. Most plans provide for the employee to forfeit their entitlement if they leave early.
- The employees identify with the company.

Unfortunately, there are detailed rules to comply with for each type of scheme, and some (particularly the SIP) are expensive to administer. The EMI scheme, on the other hand, is very flexible in the type of options granted, but the company must satisfy stringent rules before it qualifies.

We at Forbes Dawson have seen an ever-increasing use of approved share schemes, particularly the use of EMI options to reward key executives. We believe that the Budget NI changes will accelerate this trend.

If you would like any further information about incentivising employees through share schemes, please contact James Darmon at Forbes Dawson, via e-mail: james@forbesdawson.co.uk, for more details.

Share Schemes: Brief Details

In the examples below Employees 1,2 and 3 all work for the same trading company, and are granted share incentives at the same time. The employees each get the maximum entitlement under their scheme.

Share incentive Plan (SIP)

The SIP is an all-employee scheme, under which a trust buys shares for the employees. It is complex to administer, and has therefore mainly been used by larger companies to date. The company does get a tax deduction for the cost of running the scheme, including the cost of "topping up" the employee’s share entitlement.

The SIP allows the company to get shares worth up to £7,500 per annum into the employee’s hands free of tax. The employee has to contribute £1,500 towards this, out of pre-tax (and NI) income.

Provided that the employee waits five years, he only pays CGT on any sale. He may be able to use his annual CGT exemption to generate "tax free bonuses".

Unless he is a higher rate taxpayer, he will not pay any tax on dividends if he decides to keep the shares.

As an example, suppose that employee 1 pays £1,500 (with tax and NI relief) in year 1 to acquire 1500 shares. The company pays £6,000 to "top up" his entitlement. Five years later, he gets 7,500 shares from the trust, when they are worth £4 each. Three years after that, he sells the shares for £8 each. The company is a trading company. His tax bill could be nil, as follows:

Proceeds		£60,000
Cost (value on exit from trust)		£30,000
Capital gain		£30,000
Taper relief (75%)		£22,500
Chargeable gain		£7,500
Annual exemption		£7,500
Gain		£Nil

In summary, employee 1 has paid £1,500 (little more than £1,000 after tax relief). Eight years later, he gets back £60,000, on which he pays no tax.

Approved Share Option Scheme (ASOP)

The approved share option scheme allows the employee to obtain options over shares, at their current market value. There is no tax when he exercises the options, and only CGT when he sells his shares. This scheme has been available for many years. The company can decide who should get the options. They must be exercised between three and 10 years after grant.

Employee 2 is a higher rate taxpayer, who gets ASOP options over 30,000 shares at £1 each.

The CGT position for employee 2 is as follows:

Sale Proceeds		£240,000
Cost		£30,000
Gain		£210,000
Taper relief		£157,500
Chargeable gain		£52,500
Annual exemption		£7,500
Taxable Gain		£45,000
Tax at 40%		£18,000

For employee 2 the taper relief "clock" only starts to run when he pays for the shares. This means that, in order to get the taper benefit, he will need to find the cash to pay for the shares, and retain them for a period (usually 2 years for a trading company).

Enterprise Management Incentive (EMI) Scheme

EMI is targeted at key executives in smaller firms. The terms of the option can be very flexible, but there are stringent requirements on the company to qualify for EMI.

Like ASOP, EMI is a share option scheme. Employee 3 gets EMI options over 100,000 shares at £1 each. The other dates are as in the examples above.

The CGT position for employee 3 is as follows:

Sale Proceeds		£800,000
Cost		£100,000
Gain		£700,000
Taper relief		£525,000
Chargeable gain		£175,000
Annual exemption		£7,500
Taxable Gain		£167,500
Tax at 40%		£67,000

The main advantage of EMI over ASOP is that CGT taper relief starts when the option is granted (not when the shares are issued). As a result, an employee may be able to exercise his option, and sell shares the next day, with full taper relief.