Start an employee share scheme, part II

In part one of this series Lesley Stalker, tax guru at Robert James Partnership, outlined why it is the right time to launch a share scheme. In part II she explains how Entrepreneurs’ Relief can make launching a scheme even better. 

If you start a share scheme as set out in part one of this series, you might have to wait a while to see a return – largely because average asset prices are falling and make some time to recover.

So it might be some time before most entrepreneurs would consider selling their businesses, which is the most common way to realise gains from share options. 

But Entrepreneurs’ Relief provides a way to realise some of the equity in your business at a low rate of tax, whilst at the same time creating a marketplace for your employees to exercise their share options without necessitating a business sale to create that marketplace.

What is Entrepreneurs’ Relief?

In last year’s Budget, the existing taper relief system, which allowed a business owner to pay as little as 10 per cent tax on any gains made through the sale of a business asset, was abolished. 

Instead a flat rate of 18 per cent capital gains tax (CGT) was introduced. When this was met with widespread opposition and to counter the negative reaction from the business community, Entrepreneur’s Relief was introduced. 

It allows an employee who has had at least a five per cent stake in the business for at least the previous 12 months, to pay tax at the lower rate of 10 per cent on any gains made up to the value of £1 million. Thereafter gains are taxable at the standard 18 per cent rate. 

Whilst this relief exists (and it could be withdrawn at any time), it could be a useful relief to reduce the tax payable.

How does this relate to share schemes?

Very often, business owners setting up a share scheme do so because at some point in the future they anticipate the sale of their business, which would realise considerable capital gains. They wish to motivate their employees by allowing them to participate in the growth in value of the business. 

However this is not always the case. Some firms, for instance family-owned businesses, or companies which have been highly affected by reduction in valuation as a result of the recession, will not be planning for an exit within the next ten years. 

In these cases it is still beneficial to offer shares to employees as a motivational tool. It’s useful to create an internal marketplace to give employees a route for them to exercise their options. This can be done effectively whilst also providing benefit to current shareholders in the company by utilising Entrepreneurs’ Relief.

How does it work in practice?

The company starts an employee share trust which acquires shares through which it grants options to employees. The shares which the trust acquires can be new shares issued by the company, or can be existing shares which have been sold to it by existing shareholders specifically for this purpose.

If existing shareholders sell their shares to the trust, they will pay CGT on the gain they make. However they can claim Entrepreneurs’ Relief on gains of up to £1m, meaning that they receive the proceeds at an effective rate of tax of only 10 per cent.

Granting share options in the current market means employees are able to enter the scheme at a lower rate than they might have, for instance, a year ago, when business valuations were higher, and are subsequently likely to benefit from a much greater potential upside.

In recent months, whilst many businesses are struggling to stay afloat, there are an equal number still performing very well, who recognise there are always opportunities in a depressed market. 

Offering a share scheme is not a strategy for every company, but if you, as a business owner were wondering how best to motivate your employees for the long term, now is one of the best times to launch a formal scheme – as part one of my article in this series illustrated.

www.rjp.co.uk

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By LaunchLab.co.uk  on   Feb 20,2009

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Keywords

shares    employees    rewards    CGT    tax    perks    benefits   

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