Smaller companies are finding share schemes offer a cost-effective way to show employees they are appreciated.
Cash bonuses or vouchers are the simplest and most common way for employers to express their appreciation for employees. Sometimes to remain attractive to employees, businesses will also provide additional benefits such as a company car, private medical cover or the use of a holiday home.
But any type of reward will carry a financial cost to the business, including tax and national insurance (increasing from 6 April 2022 by 1.25 percentage points). With cash or vouchers there is an immediate cash-flow impact for the business. Furthermore, the business will need to consider any reporting requirements outside of an employee payslip.
Employees receive a cash bonus net of employee class 1 national insurance (again from 6 April 2022 this increases by 1.25 percentage points) and net of income tax (rate depending on level of income).
Beware that a bonus could also be included in total pay when calculating the amount of pension contributions made by the employer and employee, thereby increasing the cost of the bonus. The immediate cost for employers and employees receiving the bonus could be punitive, at worst net of 48.25% (45% additional rate income tax plus 3.25% class 1 employee NIC).
An alternative approach to rewarding employees is to use a share scheme. The total number of companies operating an employee share scheme in tax year ending 2020 was 15,340, an increase of 6% from the previous year. Companies can either award shares or share options to their employees, controlling when the shares are awarded, which could be dependent on targets achieved or number of years of service. A share scheme can be structured in various ways that could enable an employee to provide an immediate share ownership or to defer this to a later date.
It is unfortunate that many small- or medium-sized businesses have not considered some form of share award or share scheme to incentivise, reward and retain employees. With the right level of support and guidance, the process can feel nearly painless.
Why set up a scheme?
Here are some of the key motivations I have seen that drive companies to set up an employee share scheme:
- The company can retain key staff, avoiding the cost of recruitment.
- Employees feel valued and motivated by having a stake in the business.
- The company can compete effectively with larger firms for highly skilled employees.
- The share scheme is another form of remuneration for services.
- Shares can act as a performance incentive, encouraging employees to stay and work hard.
- The scheme helps develop and grow the business, which may include attracting external equity or other types of investment to support growth and scale-up of operations.
Tax-advantaged share schemes
Currently the UK offers four types of share schemes that each have tax advantages for both the employer and employee:
- Enterprise Management Incentives (EMI)
- Company Share Options Plans (CSOP)
- Save As You Earn (SAYE)
- Share Incentive Plans (SIP)
Each type of share scheme carries its own conditions and requirements that would need to be adhered to during various stages of the scheme by both employer and employee. Employees received an estimated £530m in income tax relief and £340m in national insurance contributions relief in the tax year ending 2020 from tax-advantaged employee share schemes.
Share and shares alike
Being tax efficient is not just a target for large companies – all businesses should be conscious of tax-efficient structures as a means of working towards a higher profit margin. The EMI scheme (which was the largest contributor to the total cost of tax relief out of the four employee share schemes) was specifically designed for small- and medium-sized companies, which is where a company or group gross assets does not exceed £30m.
In my experience, employees are looking at different ways of increasing their net cash flow position, which can involve reviewing how their earnings and benefits are being taxed. Furthermore, some types of share schemes can offer employers tax-favourable reliefs and therefore can afford to pass on a higher reward to employees than a cash bonus would have.