How an employee share option works
• An employee is granted an option to buy shares in the employer company at today’s market price.
• Assuming that the price goes up, the employee may exercise that option to acquire the shares at today’s price.
• The purpose of an employee share option is to act as an incentive for the employee to help to ensure that the value of the employing company increases.
The tax problem with employee share options
• Where an employee exercises a ‘normal’ share option, he or she pays income tax on the increase in value between grant and exercise.
• Thus, if we assume a key, well-remunerated employee, 40% (or even 50%) of the benefit of the option will disappear in tax.
• Even worse, if the employee retains the shares there is no extra cash with which to pay this tax.
• This is a particular issue with unquoted companies, where no ready market for the shares exists.
The solution – Enterprise Management Incentive Schemes (“EMIS”)
• Available on grants to selected employees
• Must be to attract or retain key employees
• Can write own scheme rules
• Options must be exercisable within 10 years of grant
• Objective performance targets can be set
• Not for anyone holding 30%+ of company shares
The tax benefit of EMIS
• The growth in value of the shares between grant and exercise of an EMIS option is not subject to income tax at the point of exercise.
• Instead the whole gain between grant and sale is subject to capital gains tax on sale, at 28% for a higher rate taxpayer, or 10% if the employee holds at least 5% of the company shares.
• Some trades are excluded (broadly perceived lower risk or property-backed activities)
• It is possible to issue options over different classes of shares, with different dividend rights etc.
• Options can be made to lapse if the employee leaves.
• General pre-emption rights are required to oblige an employee to dispose of shares if he or she leaves.
Summary & Conclusion
• A powerful and tax-efficient incentive for selected key employees.
• Employers can protect against employees leaving holding options or shares.
• Performance targets can be set.
• Share valuations can be agreed in advance with HM Revenue & Customs.
• Employers can devise their own scheme rules.
• So if you are interested in incentivising your key employees by granting them share options, contact Mark Simpson to learn more:
• Telephone 0161 886 8062