Incentives for Growing Companies No.6: Employee Stock Ownership Plans (ESOPs)

Employee Share Ownership Plans or Employee Stock Ownership Plans, abbreviated to ESOPs, is a term used commonly in the U.S. whereas in the UK the term is applied more generically to describe an arrangement to provide company shares to employees:

• an employee share scheme (where the employee directly holds shares or options over shares), or
• an employee benefit trust, where shares are held on behalf of the employee.

Generally in the UK, when we talk about employee share schemes there, are two types – those that have particular tax advantages, and non-tax advantaged plans.

Non-tax advantaged schemes are usually discretionary. They range from simply giving selected employees shares in the company - often with service and/or performance conditions - to options over company shares that can be exercised at a point in the future (again, sometimes subject to service/ performance criteria being satisfied). There are no specific tax advantages (although plans can be structured so as not to create unintended tax liabilities, or to control the timing of when tax becomes due). An employee is generally taxed on income and/or capital gains tax, depending on how the scheme is designed.

The other types of schemes - tax advantaged schemes - are those where HMRC allow tax efficiencies (sometimes including tax relief for the employer too). These are sometimes ignored as a viable part of an employer’s equity offering, particularly when relatively large sums are involved, but due to recent HMRC changes, (as part of the Government’s growth plan), they are worth a second look – especially as companies seek to ensure they are paying the wider workforce fairly. 

The most common tax-advantaged schemes in the UK broadly fall into either “Discretionary” or “All employee” (i.e., non-discretionary) share plans:

Discretionary Share Plans:

• Company Share Ownership plans (CSOPs) – a tax-advantaged discretionary share plan, where options can be granted over a maximum  of £60,000 per employee (recently increased from 6 April 2023). Certain qualifying conditions regarding restrictions on the use of the shares were also lifted in April – and CSOPs are now likely more attractive to growing companies who do not meet, or who have outgrown, the criteria for EMI schemes (see below)
  
• Enterprise Management Incentives (EMI’s) - the most generous form of discretionary option plan, only available to independent UK companies that meet certain trading criteria – typically smaller companies, with gross assets of less than £30m and fewer than 250 full time (or FTE) employees. Structured correctly for qualifying companies, then options can be granted per employee up to a value of £250,000 (at the time of grant). These qualify for tax relief, such that there is no income tax on grant or exercise, with any gains in excess of the exercise price being subject to capital gains tax at the point the shares are eventually sold (this assumes that the options were not granted at a discount to market value at the date of grant).

All Employee Share Plans

• Save As You Earn (SAYE) – an all-employee share plan which allows employees to buy discounted shares in their company through monthly saving, which delivers generous tax breaks.
• Share Incentive Plans (SIPs) – another tax efficient all-employee share plan which allow companies to help employees to buy shares or offer them as awards

Employees received an estimated £480 million in Income Tax (IT) relief and £280 million in National Insurance contributions (NIC) relief in the tax year ending 2021 from tax-advantaged Employee Share Schemes (ESS). Enterprise Management Incentives (EMI) were the largest contributor to the total cost of tax relief. *

The total number of companies operating some form of ESS in tax year ending 2021 was 16,330. This is an increase of 6% from the previous year. *

Despite the tax advantages, participation in the all-employee share plans – especially SAYE and SIPs - has fallen. In June 2023, HMRC launched a consultation on ways to simplify the schemes and boost awareness, in order to make them more attractive and increase take-up by companies and employees. This is important because enabling lower earners to have a stake in their employer is seen, quite rightly, as a way of creating and sharing wealth.

The criticism of the current arrangements which emerged included the length of time that employees have to wait in order to avail themselves of the tax breaks: 5 years for a SIP.

At Rem.n, when we are asked to design long-term incentive plans, our starting point is always the strategy and alignment of stakeholder and employee interest. This will not change, but it is worth considering whether there are tangible benefits in offering equity (or at least a portion of it) under a tax advantaged plan (more than one can be used), either as part of the overall incentive plan structure, or when extending equity participation to a wider group of participants.