UK: Options To Incentivise Your Employees

Last Updated: 22 February 2012
Article by Christopher Connors

One of the inevitable effects of an economic downturn is that the job market becomes restrictive, as companies have less capacity to recruit new staff, and employees may be faced with a slowing-down of their yearly salary increases. However, in such a challenging market, it is more important than ever for a company to be able to retain and incentivise its staff (whether such incentivisation is targeted at key employees, or more generally across the wider workforce). Companies in the ENR sector are no exception – indeed, where employees may be operating in isolated parts of the world (such as oil rig workers, or site workers at remote precious metal mines), it is perhaps more important than ever to adopt an 'inclusive' approach and provide some form of tangible incentive.

As the downturn lingers on, more and more companies are discovering that there are a number of different ways to incentivise their employees. With efficient planning, this can be done in a manner which adds real value to the company, as well as remunerating the individual. Such arrangements can also minimise any UK tax liability to which the company and individual may have otherwise been exposed, thereby providing a further benefit in challenging economic times.

In this, the first part of a two-part guide, some of the more common methods for incentivising employees are explored, with particular focus on their tax efficiency. In the second part of the guide (to be published next quarter), it will be assumed that a share incentive scheme has been chosen and some of the more practical requirements relating to this will be discussed, including corporate governance and 'best practice' considerations – particularly by reference to trends in the market for ENR companies.

1. Cash Remuneration

Bonus and Salary

Bonuses and salaries are taxed in the hands of UKbased employees as income. The tax consequence of this is that the employee will be charged to income tax (up to a maximum of 50%), as well as being charged to National Insurance (NIC). Additionally, the employing company will also be charged to NIC at a rate of 13.8%. As such, bonuses and salary increases are not a very tax effective form of incentivisation.

2. Share Incentive Schemes

Often, the offer of shares in their employing company is a very attractive form of remuneration for an employee. The shares can be sold, thus allowing the employee to realise cash and, where the shares increase in value, employees benefit from additional gains. Holding such shares also allows the employee to receive dividends (if declared by the company), which would be taxed as income (at a maximum rate of 36.11%). Finally, granting shares to an employee helps with motivation by 'including' the employees in the company – as well as being an employee, they will also be a shareholder once the shares are issued under the scheme. Although the actual percentage shareholding they may acquire under the scheme may be minimal, such awards often help re-focus workers on the targets and business of the company rather than merely remunerating employees (which can be particularly useful where the employees are geographically detached from the company's central management).

In very general terms, the UK tax position will be that the employee is subject to income tax (again at a rate of up to 50%) and NIC on the value of the shares acquired, due to the fact that the shares are acquired by the employee through their employment. Therefore, although share incentivisation may not initially seem more attractive than cash remuneration (purely from a UK tax perspective), there are a couple of points worth noting.

Firstly, through proper tax planning, it may be possible to reduce the tax exposure of both the employee and the company through the operation of a share scheme. Secondly, regardless of the tax consequences, many companies find share incentive schemes to be the most effective way of linking company performance to employee remuneration, and therefore such schemes are very attractive as a form of incentivisation, and often more so than a simple bonus or salary increase.

Benefits of a Share Incentive Scheme

Because share incentive schemes are generally governed by a set of scheme rules, there is scope to include a number of different elements which would not necessarily be covered by simple salary or bonus payments. For example, a set of scheme rules could include:

  • Performance criteria, which must be met before any entitlement to shares arises under the scheme. Such performance criteria can be bespoke to the company/ENR sector, and act as an effective way of linking company performance with employee remuneration. There are some common methods of measuring company performance, which will be discussed in part 2 of this article.
  • Provisions for leaving employees. When an employee no longer works for a company, the manner in which the employee leaves may affect the remuneration they receive under the share plan. A well drafted share scheme will have comprehensive provisions relating to cessation of employment, and will cover a range of circumstances, such as illness, retirement, disability and even death of an employee, as well as those employees who leave by choice.
  • Timing of awards. Rather than making awards on a regularised or fixed basis, a share scheme can contain bespoke triggers for awards to employees (such as linking to performance criteria or minimum employment periods).

3. Types of Scheme

There are a number of different incentive schemes available, and choosing the correct scheme will depend upon the commercial objectives of the particular company. A few of the more common schemes are now detailed.

Enterprise Management Incentive (EMI) Scheme

EMI schemes are tax-favoured, and the requirements and criteria for EMI schemes are contained in UK tax legislation. They are very popular as a form of incentivisation for many types of company, ranging from small private companies to fully listed ones, due to the fact they benefit from significant tax advantages. Under an EMI scheme, the employee is granted an option to acquire shares in the company at a later date, with the share price fixed as at the day the option is granted, rather than the date on which the employee actually exercises the option and acquires the shares.

If structured correctly, the UK income tax and NIC liabilities (for both employee and employer) relating to the share acquisition can be eliminated, leaving only a capital gains tax obligation for the employee on eventual sale of the shares. This is a definite tax benefit for all parties concerned. Capital gains tax is subject to a maximum rate of 28% rather than 50%, and the time at which the tax must be accounted for is later than it would be for the corresponding income tax charge. Also, because there is no NIC liability, the employee's tax liability is reduced further, and the company is not obliged to account for 13.8% employers National Insurance contributions.

Whilst the EMI scheme is very beneficial from a tax perspective, only certain companies and employees are eligible to participate in such a scheme. The UK legislation relating to EMI schemes is fairly prescriptive, and as such there are a number of conditions which need to be met for eligibility to participate in the EMI scheme. There are general conditions, as well as ones which are specifically applicable to the employee and the employing company. For example, an employee cannot receive shares having a market value of more than £120,000 (as calculated at the date of grant). Further, there are restrictions on the types and size of companies which qualify for EMI treatment. However, whilst there may be a number of applicable criteria, on closer consideration the majority of these prohibitions often prove not to be relevant for a company, or are otherwise surmountable.

Given that the qualification criteria for EMI schemes is prescriptive, when setting up a scheme it is advisable to consult a share scheme specialist, who will be able to:

  • Advise on whether an EMI scheme is appropriate, and how best to structure the scheme;
  • Identify risk areas, or any criteria which may be relevant to your company, and assist in minimising or removing any risk there may be;
  • Reduce the burden on your company by drafting all of the relevant documentation in accordance with your company's instructions and goals, as well as corresponding with HM Revenue & Customs as and when required.

Company Share Option (CSOP) Scheme

CSOP schemes are also tax-favoured, and operate broadly in the same manner as EMI schemes with generally the same UK tax benefits, although there are a few key differences. One of these differences is that the employee cannot receive shares having a market value of more than £30,000 (as calculated at the date of grant), rather than the £120,000 which can be awarded under an EMI scheme. As with EMI schemes, CSOPs also operate under a number of prescriptive requirements, and having the assistance of a share schemes specialist is therefore also highly recommended for implementing a CSOP.

Unapproved Option Schemes

In circumstances whereby a company wishes to grant options to an employee, but does not qualify for taxapproved treatment, there is still the possibility of establishing an unapproved option scheme. Due to the fact that these are not 'approved' in the same manner as an EMI or CSOP scheme, there is no favourable UK tax treatment (see Table 1). Whilst the unapproved scheme is therefore not particularly tax efficient, it still retains the elements of flexibility which often make a share option scheme a favourable option for incentivisation - indeed, because the unapproved option scheme does not need to operate within the legislative requirements applying to the EMI or CSOP, it can be tailored further to the needs of the company.

Long Term Incentive Plan (LTIP)

The term 'LTIP' is actually a fairly wide ranging one, encompassing a number of different incentive structures, and as such cannot be defined as precisely as the option schemes listed above. However, one common feature of all LTIPs is that awards made under the schemes are generally in relation to actual shares, rather than options to acquire shares.

LTIPs do not generally receive tax favourable treatment, being subject to Income Tax and National Insurance in the first instance. However, due to the fact that the employee will often receive their shares on grant rather than following the exercise of options, the LTIP can (subject to certain conditions being met) provide a specific tax benefit relating to the use of 'Entrepreneurs' Relief' by the shareholder. This relief, where available, can reduce the rate of capital gains tax payable on the shares received from 28% to 10%. For this reason, the LTIP is often a very attractive form of incentive scheme, particularly for key employees such as directors, who may be receiving a larger number of shares.

4. Conclusion

Proper incentivisation not only benefits a company's workforce, but can also maximise the return for the company itself and enhance shareholder value. However, incentivisation is often a very difficult and confusing area, and a poorly planned and implemented share scheme can potentially have the opposite effect; disincentivising employees and delivering negative returns for companies and their shareholders.

Incentive schemes (whether tax-favoured or not) can be very technical and confusing for the uninitiated, with a number of traps for the unwary. Engaging a share schemes specialist can not only maximise the effect of incentivisation for any scheme your company may implement, but will also ensure that such traps are avoided.

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