As a founder of a new business, the world of Share Incentive Plans (SIP) may seem complex, especially for those not deeply familiar with technical tax jargon. In this article, we’ll break down the intricacies and provide some insight into how to navigate the realm of SIPs with ease.
In a nutshell…
For startups, the strategy involves setting up the company with minimal initial issued capital, awarding tax-deductible free shares to employees, which become tax-free, in respect of Capital Gains Tax (“CGT”), if held in the SIP holding trust for five years.
Starting Point: Setting the Scene for SIPs
Picture a newly incorporated UK company with an initial issued share capital of £100, divided into 100 x £1 ordinary shares. Let’s say all directors and any employees (part-time employees included) are then awarded their full allowance of £3,600 worth of shares immediately after incorporation, they are then able to take advantage of a potentially major future CGT saving.
Enter the Share Incentive Plan (SIP)…
The SIP is a tax-favoured plan that allows for maximum awards of £3,600 worth of shares per person for any recipients who are UK tax resident employees or directors, per UK tax year. For any awards of shares in later years to the same or other people, the share value will depend on the value of the company at the time of the award, which means that an expert valuation will need to be carried out to ascertain the businesses value at that point in time. Hence fewer shares may be awarded if the share value increases and the business will need to pay for the valuation, which is why it is important to do this at the outset.
Tax Advantage
If the business is sold in a trade sale after the five-year holding period, it’s possible that 99.3% of shares subject to zero capital gains tax, which is a huge saving, given at the time of writing CGT can reach 20% of the gain made.
What about Enterprise Management Incentive (EMI) Options?
SIPs present advantages over EMI share options by circumventing the cap on entrepreneur’s relief. Unlike EMI options, employees do not have to pay for their shares upon exercise, and the employer benefits from a tax deduction for the SIP awards (including any tax, accounting and trustee fees).
What about Entrepreneurs Relief?
Choosing SIPs over relying solely on entrepreneurs relief is strategic. While entrepreneurs relief is capped at £1m, there is no cap on the value of SIP awards at the date of exit from the SIP trust. This is particularly advantageous for startups.
Dilution Control and CGT Advantage
Over years, other shares may be issued outside the SIP which could have a dilution effect but the initial maximum free share awards to employees ensures that the proportion of SIP shares represent a signification portion of the company’s value. This results in a substantial advantage in terms of CGT when held for the required five-year period.
Integration with SEIS/EIS Planning: A Consideration
There is also room to integrate SIP planning with Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) planning. However, careful consideration of valuation timing is crucial to avoid any impact on the overall strategy.
Navigating the world of SIPs may seem daunting, but with a clear understanding of these tips, founders can strategically leverage SIPs to enhance employee engagement, reap tax advantages, and foster long-term success for their startups. If you’re intrigued by the potential of SIPs for your business, consider seeking professional advice to tailor the strategy to your unique circumstances.
