You might be considering or already have an employee share scheme to improve your staff retention and to reward key staff. However, the recent changes on capital gains tax (CGT) affect such schemes and might have big implications for you and your staff. We asked Philip Fisher, an employee benefits and rewards partner at accountants and tax advisers PKF, to bring it all into focus.
1. What exactly are employee share schemes?
They can take many different forms but are essentially any arrangement whereby an employee can get shares in the company or group that they work for. One of these schemes is Enterprise Management Incentives (EMI), a very tax efficient government approved method of offering an employee up to £100,000 of shares in a business.
2. How are they affected by CGT?
If an employee has shares in a business and then sells them they will pay capital gains tax on the increase in share value since they acquired them. Prior to the Pre-Budget Report many employees would pay very little tax on this as they usually wouldn’t have a very large stake in the business, and they had an annual tax exemption of £9,200 which, added to business asset taper relief, meant that up to £36,800 of capital gains were not taxed.
Then in the Pre-Budget Report it was announced that this would be changed and that the allowances would be reduced. Business asset taper relief was scrapped and capital gains tax was set at a flat rate of 18%.
Since then the chancellor has altered this by adding Entrepreneurs’ Relief which would reduce the capital gains tax rate to 10% for the first £1m. But in order to qualify for this an employee must have at least 5% of the shares in a company and must have been owned the shares for at least 12 months. Needless to say most employees will not have that much equity in a company.
3. What can employees do now and how will this affect the businesses they are in?
They need to consider whether they can sell their shares or not. Many might want to as it is likely that they will pay less (or even zero) tax now than if they wait until after April 5. They must remember that this is an investment decision and saving tax may not be the only consideration. Business owners might be interested in buying them but are under no obligation to do so. Other employees at the business in question might want to buy them, or some other third party could, but ultimately if there is no market then they won’t be able to sell.
There has been a lot of speculation in the press about owners rushing to sell businesses since the Pre-Budget announcement and the same could be said for employee shares. Also, it is likely that the reason many were given share options is because business owners wanted to retain their services in the long-term or reward them for their efforts in a cost-effective way – I think that in some cases the changes could seriously undermine this goal.
4. And the future of employee share schemes?
It might mean that smaller companies are more reluctant to use them as they will be regarded as being less attractive than before. If that is the case then it would be a real shame.
5. So why did the chancellor do this?
To start with there was a lot of publicity surrounding ‘fat cats getting fatter’ and in particular venture capitalists were singled out. The chancellor reacted to the publicity by abolishing business asset taper relief in his Pre-Budget Report and setting a new flat rate for capital gains tax at 18%.
This drew a lot of criticism from business lobby groups and some people actually claimed that it made the tax system more complicated. However, it was in fact a simplification and these should normally be welcomed. But once again the chancellor reacted to the pressure and introduced entrepreneurs’ relief which has, in fact, made things more complicated and will not help most employees.
6. What will the result of this all be?
We are still waiting for the supporting legislation on all of this so we don’t know how it is all going to actually work. I think there’s going to be a madcap period of activity in the next few weeks, while everyone tries to get their tax arrangements into place, and that isn’t good for business or anyone else. The Budget is on March 12 and for all we know the chancellor might change his mind again. One of my colleagues has written to Mr Darling suggesting that he waits a year before this is introduced – who knows he might listen?
Philip Fisher is the employment tax and rewards partner at PKF (UK) LLP. He can be contacted at
philip.fisher@uk.pkf.com
