Competition for talent is compelling businesses to explore different options to attract and retain employees. Enterprise management incentives (EMIs) are a popular option, but there are strict eligibility requirements. Your business may not qualify or could have outgrown the arrangement if your headcount exceeds the equivalent of 250 full-time employees, is part of a group with gross assets exceeding £30 million, or there are structural changes (eg, after a private equity investment).
There's often an expectation in senior management teams that equity incentives form part of their remuneration packages, especially if they have had options in the past (such as EMI). Recent changes to the Company Share Option Plan (CSOP) legislation, however, may mean that an organisation can now take advantage of or continue to offer tax-advantaged incentive arrangements to reward their key employees, even where EMI is no longer available. In addition, you can continue to explore other share-based incentives, such as growth shares, which remains popular among rapidly-growing businesses. You can also combine the benefits of a CSOP with growth shares.
The UK tax-advantaged CSOP is the next choice once a company no longer qualifies for EMI, as unlike EMI, the CSOP legislation doesn't include requirements around employee numbers or balance sheets. Provided the necessary conditions are met by all relevant parties (such as typically a three year vesting period except where there is an earlier general offer for the company concerned), no income tax or NICs (employers or employees) will arise on the grant or exercise of a CSOP option and subsequent acquisition of shares. Capital gains tax (CGT) is payable on the subsequent disposal of the shares acquired on the exercise of the CSOP. This is far more favourable than ‘unapproved’ options, which would be subject to income tax and possibly NICs on exercise and acquisition of the shares.
Two welcome changes have been made to CSOPs which came into effect from 6 April 2023. The first is a relaxation in the requirements relating to the share class over which CSOP options can be granted. The second is the doubling of the maximum value of shares which can be awarded under a CSOP from £30,000 to £60,000 (valued at the date the CSOP options are granted).
Following these changes, companies with more ‘complex’ ownership structures, such as minority private equity-backed businesses are more likely to qualify for CSOP.
Growth shares are another tax efficient-incentive arrangement, which a company can consider when it no longer qualifies for EMI. Under a growth-share plan, participants are awarded a class of share that only delivers value once the business has grown in value above a pre-defined performance hurdle. The gain above the performance hurdle, if structured correctly, is subject to CGT, as opposed to income tax and NICs.
Shares will have a value on award, which is determined via a tax-valuation exercise. The inclusion of the performance hurdle should reduce the upfront value of the shares, thereby making them affordable for participants to subscribe.
As an example, if the growth shares are valued at say £1,000 on award, and assuming the value of the company increases and therefore the performance hurdle is exceeded, the shares will be entitled to share in the value of the company, usually only receiving the value above the level of the performance hurdle. If on disposal of the growth shares the shareholders are entitled to receive £100,000, the growth in value of £99,000 will be subject to CGT and not the higher income tax rates and potential NICs.
Shares will have a value on award, which is determined via a tax-valuation exercise. Here the shares are valued at £1,000 on award, and assuming the value of the company increases and therefore the performance hurdle is exceeded, the shares will be entitled to share in the value of the company, usually only receiving the value above the level of the performance hurdle. If on disposal the growth shares are valued at £100,000, the growth in value of £99,000 will be subject to CGT.
The restrictions relating to the class of shares over which CSOP options can be granted have been relaxed. Combined with the doubling of the individual employee CSOP option limit to £60,000, this has had a significant impact on the ability to continue to incentivise and reward employees via shares.
Companies that want the benefits of both now have the opportunity to combine growth shares with a CSOP option. This combination has three key benefits.
The up-front cost to participants in respect of the growth shares is deferred until the CSOP options are exercised. The disposal proceeds on a sale of the shares can be used to fund the exercise price if the exercise of the CSOP options is linked to an exit.
The value of the shares under option can be agreed with HMRC prior to the grant of the options, which provides peace of mind and certainty around the tax treatment.
CSOP options also remove the administrative burden of minority shareholders, particularly in the case of early leavers where their options would typically lapse.
Provided the necessary CSOP conditions are met, no income tax or NICs will arise on the grant or exercise of a CSOP option and subsequent acquisition of shares. CGT (up to 20% at current rates) is payable on the subsequent disposal of the shares acquired on the exercise of the CSOP.
For more insight and guidance, get in touch with Dominic Merlin-Cone, Emma Selway, or Andrew Morgan Jones.
