The government has over the recent years reduced the amount of contributions that high earners can pay into their pension schemes. Currently there is a cap of £ 50,000 for pension contributions (unless past years missed contributions are rolled forward). Of course the majority of employees with works pensions cannot afford to contribute the maximum pension. So these larger pension contributions are normally made by the directors of SME’s. Alternatively by employees paying substantial PAYE who would rather contribute to their pension than donate their hard earned monies to HMRC.
It is well known that the government, concerned about the increasing use of employee benefit trusts (EBTs), employer-financed retirement benefits schemes (EFRBS) and other arrangements as a means of tax avoidance by business owners have introduced additional legislation to restrict activity in these areas.
Both Employee Benefit trust and E-Furbs typically used to allow an employer to establish such structures on behalf of employees and at a later date the trustees of the EBT would grant an interest-free loan to the employee or a family member. Tax would be charged on the basis of the value of the loan to the employee, that is the interest (at a commercial rate) not paid, rather than the actual money received. The EBT’s and subsequent loans were increasingly being used for tax avoidance rather than the settlement of a trust fund for all employees.
The loan could then be written off at a more tax-attractive time, for example when the employee was no longer employed and perhaps a non-UK resident. In view of the government’s legislation, employers/employees will need to turn their attention to other methods of providing employee benefits.
A contribution to a registered pension scheme, either a works pension or a private pension will be the main and most tax-efficient method of employee retirement provision. Aggregate contributions of up to £50,000, and possibly more if advantage can be taken of the annual allowance carry forward provisions, are permitted with full tax relief.
Any employer contributions to a registered pension scheme will need to be paid ‘wholly and exclusively’ for the purposes of the trade if they are to be tax relievable. Any member contributions will only be subject to tax relief if they do not exceed 100% of the member’s relevant UK earnings.
Top-ups can be paid to existing Employee Benefit Trusts, which still offer generous tax advantages in terms of tax deferral, although the employer will only get a corporate deduction for contributions when benefits are paid and have PAYE and NIC levied on them.
All of the above legislative changes mean that employers are seeking to find ways to reward the employees of a company and that includes the Directors.
For that reason it is worthwhile to consider the use of company share schemes.
There are two types of scheme available. Unapproved Share Option Plans and Enterprise Management Incentive Schemes.
It is worthwhile noting that unless specific tax rules apply, any share-based benefit passing from an employer to an employee will be subject to income tax and possibly also to national insurance contributions (NICs). Costs can begin to total up dramatically for additional rate taxpayers (Additional rate of tax is currently 50%. This will reduce to 45% for 2013/14). This means a large part of your potential gain is swallowed up and this is the case with an Unapproved Share Option Plan (USOP).
As the tax benefits of unapproved schemes are inefficient, companies will normally seek to make use of one or more of the government sponsored schemes, under which gains are normally taxed at the more favourable capital gains tax rates
One of the most popular government sponsored schemes is the Enterprise Management Incentive (EMI). The EMI is a highly tax-efficient method for providing targeted incentives to key employees or employee groups. Participant tax for EMI schemes is 18% for lower rate taxpayers, or 28% for higher rate taxpayers. It is structured as an option scheme, whereby the employee is granted the right to purchase company shares in the future at a price set at the date of grant. The employee gains when the value of the shares rises above the purchase price and value is usually realised on an event i.e. sale of the Company.
The difference between an EMI scheme and a USOP are colossal when considering the tax implications, but the possibility of saving more of your gains does not end there. Due to the proposed changes involving the legislation interaction of EMI option exercise with availability of CGT Entrepreneurs’ Relief, participants may, depending on when they exercise their options and when they sell the shares, now be looking at an astonishingly low effective rate of tax of just 10% regardless of the size of their equity interest.
Latest News on Company Share Schemes
Previously, the criteria needed to qualify to establish eligibility for Entrepreneurs’ Relief included holding 5% of the share capital that equated to 5% of the voting capital (i.e. shares had to carry voting rights), and the participant must have held the shares (rather than the options) for at least 1 year prior to sale.
Now, provided the legislation is enacted next year as currently proposed, you no longer have to hold any defined amount of equity, nor voting shares and the only requirement to qualify for Entrepreneurs’ Relief in relation to shares acquired pursuant to the exercise of an EMI options is that the participant must still hold the held shares for a year prior to sale.
It appears there has never been a better time to consider an EMI scheme or to take a renewed look at an existing plan. If you would like more information about the benefits of share schemes, including EMI, please contact us on 01189 347 920 or e-mail us on firstname.lastname@example.org.