how to use employee share schemes (and pay as little tax as possible)

Linda J. Dodson

In Tax Hacks, our columnist Mike Warburton – previously a tax director with accountants Grant Thornton – brings you his best tax-saving tips

Many companies offer shares as a way to retain talented staff. But there are lots of different schemes, each with their own quirks and potential for being caught out.

Should you take the plunge? Read on to find out.

Unless it is an approved scheme (see below) when you are given the opportunity to buy shares in the company that you work for, you will pay income tax on the difference between the market value of the shares and the price paid. Where the company is listed this “profit” will be taxed through the PAYE system with National Insurance applying just the same as if you had received a bonus.

Listed companies usually offer a “sell to cover” facility whereby a proportion of the shares are immediately sold and the proceeds retained by the company to pay this PAYE liability. Your base cost for capital gains tax is then the market value of the shares at that time.

For capital gains tax purposes it is as though you had bought the shares in the stock market that day. As with any other share purchase it is important to keep records. If you are given the opportunity to buy shares over several years you will need to keep a record of the CGT base cost of the pool. You can see how this pool works by reading HMRC’s relevant manual here, with examples here.

Companies offer share schemes as a way of incentivising their employees and encouraging them to stay with the firm. For this reason many share incentive schemes are established where shares are initially awarded for you but held in reserve for a period of perhaps three years. Until that time you are not the legal owner.

Only after that period has elapsed will the shares pass into your ownership, known as “vesting”. It is then that tax may be due. If you are no longer an employee the opportunity lapses.

Share option schemes: a one-way bet

Alternatively the company may offer you a share option scheme. The position is similar except that the company offers you the option to acquire shares at some time in the future. If you choose to exercise your option to buy the shares at the option price you will be liable to income tax on the difference between the market value of the shares and the total of their cost and any price paid for the option.

The hope is that the shares have risen in value but if they have not there is no obligation to buy them. In that way it offers a one-way bet.  

With the top CGT rate on shares at 20pc the key is to exercise your right to buy shares when you think the share price is low so that more of the eventual profit is taxed as a capital gain rather than as earnings. If that is also a low income year for you and it keeps you outside higher income tax rates, so much the better. Incidentally, with share incentive schemes dividends may be paid in the vesting period and reinvested but may still need to be declared on your self-assessment.

The four ‘approved schemes’

The big tax savings arise with approved schemes. There are four types currently approved by HMRC. For more on these, see here.

  • Approved Share Incentive Plans (SIP)
  • Save As You Earn plans (SAYE or Sharesave)
  • Company Share Ownership Plans (CSOP)
  • Enterprise Management Incentive schemes (EMI)

It is always worth finding out if your company offers any of these arrangements. As with unapproved schemes there will be a period between the share award or when the option is granted and the opportunity to acquire the shares.

Provided the qualifying conditions are met the main tax advantage is that no income tax or NI will be due when you acquire the shares regardless of how much the value has risen in the option or vesting period. Tax will only arise when the shares are sold and the overall profit is all then treated as a capital gain rather than as earnings.

This means that you can take full advantage of your annual CGT allowance, currently £12,300 and pay a maximum of 20pc on the rest. You can also transfer shares free of tax to your spouse or civil partner which will allow them to use their own CGT annual allowance. They may also benefit from any of their unused basic-rate band for which the CGT rate will be just 10pc.  

About 25 years ago there was a fuss when bosses of some privatised utility companies were awarded generous approved share options. David Dimbleby asked me how they operated. I explained that the executive could exercise their options free of tax, pass some of them to their wife (the bosses were all men in those days!) who could then cash them in at low tax rates.

I ended with a flippant comment that privatised utility bosses should all have a non-working wife to save tax. The first question BBC Question Time that evening? “Would the panel recommend privatised utility bosses to have a non-working wife as a tax dodge!”

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