There are many reasons why a company may want to incentivise a director or employee via the grant of share options or the issue of shares.  This could be for recruitment or retention purposes or to ensure that company and individual objectives are aligned.

1. Grant of share options

“Exit only” share options can work particularly well if a company is planning towards an exit event in the medium term, such as a sale or flotation.  The employee does not become a shareholder until immediately before the exit event so the existing share ownership structure and dividend policy of the company is unaffected.  Options can be structured to lapse on the date the individual’s employment ends.  

The use of Enterprise Management Incentive (EMI) options can facilitate income tax and NIC exemption on the growth in value of the option shares between grant and exercise. This enables the employee to potentially benefit from a 10% CGT rate, via Business Asset Disposal Relief, on the gain made on sale of the shares. 

2. Issue of shares

In other circumstances, the company may wish to issue shares upfront to the director or employee concerned.

This gives rise to various share valuation, tax and legal considerations.

The market value of the shares (less any price paid) is deemed to be employment income in the hands of the employee. The employee will then have to report the amount in question and pay income tax thereon via the self-assessment regime.  In certain cases, PAYE and NIC may apply instead.

The employing company will be obliged to register an employee share scheme and file an annual return reporting details of the share acquisition online to HMRC by 6 July following the end of the tax year.

It will be necessary to undertake a tax valuation of the shares so that the company and employee can comply with their HMRC reporting obligations.

If the shares are subject to restrictions, the company and employee should consider making a s431 election to ensure that any future growth in value in the shares falls within the more beneficial CGT regime.

3. Practical and legal considerations

You will also need to consider what would happen to the shares in the event of the employee ceasing employment.  Good and bad leaver transfer provisions in the Articles of Association or a shareholders’ agreement may be required.

You may require a separate class of shares, so that the dividend extraction policy of existing shareholders is unaffected.

4. Corporation tax relief for employee share acquisitions

The corporation tax legislation contains a valuable relief, enabling a 19% corporation tax saving. It enables the employing company to claim a trading deduction for the amount of employment income which the employee is treated as receiving on acquiring the shares (or would be treated as receiving but for an applicable exemption).

By Sheldon Cole, Partner

If you need advice on any employee and director share incentive scenarios, please speak to your usual Thomas Westcott contact.