Aesop's tables.

The Finance Act will introduce two new schemes aimed at boosting profits by motivating staff with free shares. Trevor James explains why employers should be interested

More than a year ago, the Chancellor announced two new share schemes aimed at boosting employee share ownership. Following royal assent of the Finance Act, employers will be able to use these to motivate staff. Existing schemes such as the SAYE approved profit sharing and executive share option schemes will still be available, but tax breaks on the new all employee share ownership plan (Aesop) and the enterprise management incentive scheme (EMI) should guarantee the interest of all eligible businesses.

The Aesop scheme is appropriate for most companies and groups, but it is perhaps most suitable for quoted companies. The scheme has four elements -- companies can pick and choose, but the shares element must be held in a UK trust.

Employers will be able to give up to 3,000 [pounds sterling] of free shares to employees each year and they can link all or some of these shares to individual or team performance. Staff can also buy up to 1,500 [pounds sterling] of partnership shares out of gross salary (ie they get tax and national insurance (NI) relief -- a saving of either 22 per cent, 32 per cent (with NI) or 40 per cent). Employers can match these partnership shares at a ratio of up to 2:1. And any dividends up to 1,500 [pounds sterling] accruing on the shares while in the trust can be used to buy more shares (dividend shares). In total, therefore, an employee could receive 3,000 [pounds sterling] of free shares, buy more for 1,500 [pounds sterling] and receive another 3,000 [pounds sterling] for free, plus dividend shares.

The employee's tax position gets better the longer the shares stay in the trust. If the shares stay in the trust for at least five years (three for dividend shares) no tax will be due on them. They come out of the trust at current market value and can be sold immediately tax-free. If they are not sold, they will benefit from business taper relief (if unquoted or employee shares). If the shares are withdrawn before three years, income tax is due on the market value at the time of withdrawal (or on the original value of the dividend on dividend shares). If they are withdrawn after three, but before five years, tax will be due on the lower of original value (or salary foregone) and current market value.

The employer will receive full tax relief for the scheme. In addition, they will get full relief for the salary used to buy partnership shares and will save employer's NI on this salary. But if the employee leaves in the first three years the employer will have to pay NI on the value of the shares when they are withdrawn. Between the three years and five years, withdrawal can incur an NI charge on the lower of the current value or the value when the shares were acquired under the plan. There is also corporate tax relief on the value of the free and matching shares. With such tax breaks, Aesop should be considered by all quoted companies.

EMI is an option scheme aimed at young growing companies. But it could also be used by other companies with gross assets of 15 million [pounds sterling] or less, which are independent and carry on a qualifying trade. A qualifying company can grant EMI options to up to 15 key employees. These people must be employed in the company (or group) for at least 25 hours a week, or 75 per cent of their working time if less. Employees must not have a material interest over 30 per cent or more of the company.

The value of the shares over which the options are granted must not exceed 100,000 [pounds sterling] on the day of grant. The options can be flexible and there is no minimum exercise period (maximum 10 years). The exercise price can be less than market value. Any discount at grant would be taxed only on exercise (possibly liable to PAYE/NI if the shares are readily convertible at that time). The shares can be subject to restrictions and forfeit (but watch out for other tax traps).

The employee will receive generous tax breaks compared with unapproved options and existing approved schemes. With an unapproved option, staff pay income tax on exercise. Usually the shares will be readily convertible, so the tax will be due immediately under PAYE. In addition, NI will be due from both employee and employer. The employee will be able to pay the employer's NI and receive tax relief on the contribution. At current rates, this gives an effective tax rate of 47.32 per cent for a higher rate employee.

With an EMI option, there is no tax on exercise, except on the value of any discount, and capital gains tax will be due on disposal. The main tax break for EMI options is that business taper relief accrues from the date of grant of the option, not the exercise date. The company will be allowed corporate tax relief on all set-up costs.

EMI a twork

100,000 options granted at 10p per share when shares valued at 1
[pounds sterling]. After four years the employee exercises and sells at
10 [pounds sterling]. The employee agrees to pay the employer's NI
liability.

EMI                  [pounds                    [pounds
                     sterling]                  sterling]

Discounton grant
taxed on exercise    90,000 X 40% (tax)   =     36,000
                            X 7.32%(NI)   =     6,588
                                                42,588
Growth in value      900,000 X 10%        =     90,000
Total                                           132,588
Effective rate                                  13.4%

Unapproved           [pounds                    [pounds
Gain                 sterling]                  sterling]

                     990,000 x 40%        =     396,000
                             x 7.32%      =     72,468
                                                468,468
Effective rate                                  47.32%

Trevor James is a partner at PricewaterhouseCoopers. Additional reporting by Neil Taylor, senior manager at PwC