A driven and motivated workforce

The Government has created a number of arrangements that are designed to encourage share ownership by employees of privately owned companies. These arrangements aim to encourage a broader company ownership whilst providing the business and the existing shareholders with potential rewards for diversifying the ownership.

In essence the message that Government is trying to put across is that if an employee owns part of the company then they are more inclined to work harder for its success. This should consequently improve business performance, help it grow and increase its value. This increase in value benefits the company, the new employee shareholders and the existing shareholders. So potentially everybody wins!

So why doesn’t everybody do this? Well firstly the employee and shareholders only benefit from an increase in value on the sale of the shares. This may require the sale of the whole company and could be some time in the future - if ever. Therefore owning shares may not be that big an incentive for an individual, they may prefer an annual bonus or pay increase rather than the promise of potential value in the future. The key point here is that the incentive arrangement needs to be designed to drive the response that the business is looking for. For key personnel who are pivotal to the long term success of the business and a future sale then shares can be an excellent incentive mechanism, for others a bonus or pay rise may be more effective.

Of course not all business owners are keen on giving away part of their company. However, if they give away for example 10% of the company and that helps drive a 20% increase in total value of the business then their investment will have increased in value by 8% - so they still win.

There are quite a few ways to transfer shares to employees with differing tax consequences. Two tax beneficial arrangements for SMEs are the Enterprise Management Incentive Scheme (EMI) and the Employee Share Scheme (ESS). Under EMI the employees usually have the right to acquire shares in the company just before the company is sold, but at a price agreed today. The profit on sale is taxed as a capital gain with a 10% tax rate and the company can claim a deduction against profits equal to the employee’s profit on sale. Obviously this is very tax efficient for both the employee and the company. However, the employee does not own any shares until just before the sale but does not pay for the shares until then and does benefit from the potential upsides with no downsides.

The other beneficial arrangement is ESS where an employee can be given shares worth between £2,000 and £50,000. However if the shares are worth more than £2,000 then the employee is taxed on the excess over £2,000 and this could be at a rate of up to 62%. On a future sale of these shares then the employee is not subject to tax on the sale. The tax on sale is obviously far more beneficial under ESS but there is the potential for a large upfront tax bill for the employee. So these arrangements need to be structured carefully.

Both of these arrangements can provide significant incentives and rewards for key employees and the choice of the most appropriate arrangement will depend on the circumstances of the business. However getting it right can drive value for the company, the key employees and the existing shareholders on a future sale of the business.

Trevor Shaw , Corporate Tax Director