GrowthBusiness.co.uk: Your gateway to entrepreneurial success

If you can’t afford to give key staff a pay rise during the recession, it could be a good time to introduce a company share scheme. Lesley Stalker, head of tax at accountancy firm The Robert James Partnership, explains why.

All assets, including your company, lose value during a recession. That’s generally not regarded as a good thing, but there are a few benefits, one of them being the opportunity to give away a stake in the business to valuable employees who could see a big uplift in the value of that stake when the inevitable recovery comes.

This is a powerful motivator for valuable staff in cash-constrained times, when pay increases may not always be possible but you need maximum commitment from your team. There’s also the advantage of being able to apply a time frame to the right to exercise share options, say after two or three years, which will help to retain staff who contribute directly to business growth.

One scheme that enables you to do this while benefitting from tax advantages is the Enterprise Management Initiative (EMI). There are certain eligibility criteria: your company must have fewer than 250 employees, for example. You also need HMRC to accept your valuation of the shares over which you are granting options.

The idea is that you grant selected key employees the future right to buy shares in your company at a price which is fixed today. When the economy recovers and the shares in your company increase in value, employees can exercise their right to buy the shares at the original price, and potentially sell them for a profit.

Very often, share schemes are set up to allow employees to exercise their options and sell immediately afterwards, at the point of a company sale. But it is also possible to create an internal marketplace for trading your company’s shares and this can offer additional tax benefits.

Here’s an example. You own an advertising agency and its shares have been agreed by the shares and assets valuation team at HMRC to have a market value of £10 each. Your company launches an EMI scheme under which employees are granted an option to buy a set amount of shares for £10 per share. Four years later you agree to sell the business and each share is now valued at £100 (let’s take an optimistic view). Employees exercise their options and immediately sell their shares, making a £90 profit from each share owned. The company receives corporation tax relief at the point options are exercised, based on the difference between the market value of the shares at the date of exercise, and the price paid by the employees.

As an additional bonus for your staff, capital gains tax will apply (at 18 per cent) when the shares are sold, rather than income tax (at a top rate of 40 per cent) when the share options are exercised.

It’s important to stress that only recognised share schemes, in which the proper procedure is followed, will attract tax relief. The key thing is to make sure your initial valuation of the options is agreed with HMRC, otherwise the figure could be disputed in future giving rise to an additional tax liability at the 40 per cent level.

Executed properly, however, staff share schemes provide an incentive that directly links the performance of key staff, and therefore the company, to their eventual reward.

Read the second article in this series on staff share option schemes.