ESOP (Employee Stock Ownership Plan) in the United Kingdom

There is a growing sense of urgency among company owners nearing retirement age to make plans for the future of their companies and, by extension, their legacies. Several shareholders are eager to move up the timing of company transactions as worldwide tax rates are projected to rise. There are several potential ways out of a corporation, including selling to an outsider or passing control to an inside group or a family member. Concerns about their legacy, the well-being of their workers, and the financial security of the organization may make this a difficult choice for business owners.

There are several ways to go about this, but selling stock to workers is becoming more common throughout the world. This is essentially why business owners choose Employee Stock Options Plans as a part of their compensation strategy. To help you understand the benefits of ESOP in the UK and identify if the regulations under ESOP taxation in the UK are favorable for employees, this article covers everything you need to know about the plan.

ESOP in the UK

An Employee Stock Ownership Plan, allows workers to purchase stock in their corporation at a discount. The phrase is used to describe a wide variety of instruments and incentive schemes that are popular among the new, upwardly mobile salaried class and are intended to encourage, reward, compensate, and retain high performers. Both the workforce and the business stand to gain from ESOPs, or Employee Share Ownership Plans, which facilitate the purchase of company stock by workers. There are a few variations on ESOPs, but in general, companies may offer to grant or sell ‘options’ or ‘shares’ to their workers and contractors, or they can build up bonus ESOPs depending on the success of the firm.

Understand ESOP in the UK

When a firm offers its workers the chance to purchase shares in the business, it is known as an ESOP. A person who owns shares in a corporation has a partial stake in the earnings or assets of that company. Employees who hold stock in a successful firm may see their investment grow in value. Every business, no matter its size, may benefit from this strategy, although it is most common among companies with closely held stock.

Owners may increase workers’ investment in the firm by giving them stock options. For instance, employees may be more motivated to work hard if they believe that their efforts will contribute to an increase in the company’s market share. Retirement plans may also be structured as employee stock ownership schemes. Similar to other plans, they are governed by a set of rules and regulations but are funded exclusively by the business.

How does ESOP work in the UK?

For the workers to take part in this program, they will not be asked to make any further financial contributions. Companies may establish ESOPs for their staff for a variety of motives.

• To motivate one’s workforce
• To create a trading platform for stockholders who want to liquidate their holdings
• As a means of encouraging workers and rewarding hard work
• To maximize one’s tax savings

Types of ESOP in the UK

The employee stock ownership plan may be initiated in a company with the assistance of some kind of direction and the involvement of an accountant or financial manager. ESOP in the UK takes a few forms as the following.

• Incentive Stock Options (ISO) – Since they are eligible to obtain favorable tax treatment, many frequently refer to them as qualified stock options. There is no obligation to pay income taxes upon grant or exercise rather, the tax obligation is put on hold until the stock is sold.
• Non-qualified Stock Option – Stock options that do not qualify for employee tax benefits are known as non-qualified stock options (NSOs). NSOs are subject to taxation both at the time of exercise (the purchase of shares) and again when the shares are sold, in contrast to ISOs, which are exempt from taxation at the time of exercise.
• Put option – Here, the writer (or seller) and the buyer of a put option enter into a legal and binding contract. Purchasing a call option gives the buyer the right, but not the obligation, to sell the underlying asset to the option seller at the strike price within a time frame. At the option’s strike price, regardless of fluctuations in the market, the seller must purchase the underlying asset from the option buyer. There is a cost (the option premium) associated with acquiring an option from a seller or option writer like the purchase of a put option, insurance coverage, etc.

Benefits of ESOP in the UK

Employee stock ownership plans (ESOPs) provide workers with a chance to invest in their companies in a tax-efficient fashion, with the potential for high profits (depending on the plan), and sometimes without requiring them to come up with a sizable down payment. An option, for instance, may not incur a tax liability until the employee realizes a financial gain from it, either via vesting or exercising. An NCEO study reveals that employees who work for organizations in which they have partial ownership have, on average and across industries, better employment, benefits, earnings, and wealth than their counterparts who do not have employee ownership. The following are the benefits of ESOP in the UK:

• Flexibility in the company – The ability to maintain one’s shares upon retirement or leaving the firm is a major benefit of employee stock ownership plans. This ensures that they continue to have a say after they’ve left the firm. Employees who have been with the firm for many years and have a sense of loyalty to it may benefit from this.
• Simple scheme – It’s simple for all workers to take part in employee stock ownership schemes. The strategy is all-inclusive since participants need not contribute any money of their own to reap the rewards. Employee stock ownership programs are a straightforward way for businesses to show appreciation for their workers and incentivize them to do a better job.
• Increase job retention – With a stake in the company’s success on the line, workers who participate in an ESOP are more probable to stay committed to the business. Employees who purchase company stock are essentially treated as partners in the business. Share schemes work best when tied to employee engagement programs. There is a correlation between employee engagement and positive outcomes including higher productivity, more work satisfaction, and lower absenteeism.
• Tax benefits – The government of the United Kingdom is so committed to the concept of employee ownership that it has provided large tax breaks to shareholders and workers of companies who adopt an employee ownership system. If you are a UK tax resident and you sell shares in a trading firm, you may keep all of the gross profits after paying any applicable capital gains tax.

The downside of ESOP in the UK

Even though there are many situations in which offering stock options to employees might be beneficial, such programs are not a cure-all. Administration costs for stock incentive programs tend to be higher than those for cash reward programs. The volatility of share prices makes the potential payoff difficult to gauge, which is a major problem in uncertain economic times. Companies understand this, and therefore they often make attractive share offerings, such as free rewards, discounts, or matching share offers. Share plans, on the other hand, nearly never leave workers out of pocket if the firm does not succeed.

How to set up ESOP in the UK?

Setting up an ESOP plan for your business from scratch can be an extensive process. But with the right consultation and support from a financial expert, you can establish one successfully. However, here is how a typical ESOP establishment takes place.

• Setup employee ownership trust – The shares are held by a trust, which is a separate legal entity from the firm. Companies may make contributions to the trust, which can subsequently be used to acquire stocks and shares from other parties. The corporation may avoid funding the trust by issuing more stock. The total price of these shares cannot exceed their current market value.
• The trust purchases shares – When the trust has been established, it will be able to make stock purchases directly from the corporation. In most cases, a third-party appraiser is entrusted with the task of establishing the share price.
• The trust distributes the shares – After that, the stocks are distributed to the workers. The number of shares an employee receives may be proportional to his or her salary or length of service. They may be eligible to receive additional shares of stock based on the number of years they have worked for the firm.

Legal Consideration of ESOP in the UK

There may be tax benefits associated with receiving business shares from your employer, such as avoiding Income Tax and National Insurance upon the value of the shares. An employee shareholder is someone who has invested at least £2,000 into their employer’s stock. If you or someone related to you (such as a business partner, spouse, or family member) own 25% or more of the company’s voting rights, you will not qualify for tax relief. Employers are obligated to cover the costs for an employee shareholder’s consultation with an impartial expert about the agreement’s provisions and their potential consequences. Benefits from this suggestion are not subject to taxation.

Employee Ownership Trust vs Employee Ownership Plan in the UK

The United Kingdom and the United States are home to some of the world’s most progressive tax policies for employee ownership. The directors and shareholders of a firm would be wise to sell the company to the workers now because of the favorable tax legislation in both nations regarding employee ownership.

When a business is sold to its workers in the United Kingdom via an Employee Ownership Trust (EOT) or in the United States through an Employee Stock Ownership Plan (ESOP), it is really an employee ownership model. The EOT and ESOP solve succession difficulties for family-owned firms, generate an instant buyer for the company, and enable workers to become more involved in the organization.

According to studies conducted in both countries, the employee-ownership model may serve as the “go-to” model for a corporate sale when employees are the company’s most valuable asset because it fosters higher levels of employee engagement and loyalty, greater motivation for innovation, and better business performance.

Employee Stock Ownership Plans are similar to EOTs in many ways, but the main distinction is that workers in ESOPs hold their beneficial shares in retirement accounts and get money from the firm when they leave or retire. Employees under an EOT model do not take physical possession of firm shares, rather, a trustee maintains the shares in trust for the benefit of all workers.

How does ESOP taxation work in the UK?

It is possible to tax or not tax share systems based on the regulations of HM Revenue and Customs (HMRC). HM Revenue and Customs is the government department in charge of ensuring that businesses comply with tax and customs regulations and pay their employees a fair minimum wage. If HMRC considers the plan to be “authorized” participants may be eligible for tax breaks. In other words, shareholders won’t be subject to any kind of taxation, either income or capital gains.

The option holder must also be an employee to exercise it. Hence, they cannot be a hired advisor or a non-executive director. If you are a UK tax resident and you sell shares in a trading firm, you may keep 100% of the gross profits after paying any applicable capital gains tax. Furthermore, the director of an EOT may make annual bonus payments to employees totaling £3,600 without incurring any tax liability.

Manage your ESOP with Eqvista!

To fully take advantage of the benefits that an employee stock ownership plan (ESOP) may provide, it is important to have a thorough understanding of how they work. Developing the strategy from the ground up could appear like a difficult task. Nevertheless, this is precisely why you need to get in touch with a professional financial team like Eqvista. You may manage your shares, complete the required reports, and maintain an orderly cap table with the help of our cap table software intended to fulfill all of the criteria. If you want to learn more about our services, feel free to reach out!