Share Incentive Plans (SIPs): What Are They & How Do They Work?
The UK has several different types of government-approved share scheme. In this article we'll cover share incentive plans, one of just a couple of all-employee share plans in the UK.
What is a share incentive plan (SIP)?
Share incentive plans are a type of employee share scheme active in the United Kingdom. SIPs were introduced in 2000, and have become a popular way for founders and company leaders to distribute shares to all employees.
SIPs are one of the four official government-approved share plans and need HMRC approval to set up – the others are Save As You Earn (SAYE), Enterprise Management Incentives (EMIs) and Company Share Option Plan (CSOP) schemes. Generally speaking, government-approved schemes offer more significant tax benefits to companies and teams compared to unapproved schemes.
How do share incentive plans (SIPs) work?
The shares awarded as part of a SIP must be part of the company's regular share capital. Whether or not SIP shares have voting rights is decided at the company's discretion. There are several different types of share that can be granted under a SIP. Let's take a look at the options.
Companies setting up share incentive plans have a quota of free shares that must be granted to each employee. Each employee can receive up to £3,600 per year in free shares. Employees cannot withdraw free shares for between three and five years, depending on the terms of the plan.
Free shares have to be withdrawn from the SIP once the employee leaves the company. If the shares are sold once they're withdrawn, there is no capital gains tax due. If shares are retained after withdrawal, CGT may be due on gains (see capital gains tax section below).
Partnership shares are awarded out of each employee's pre-tax salary. Employees can purchase partnership shares worth whichever is the lesser of £1,800 of the employee's salary or 10% of their income each year.
There is more risk involved for the employee when purchasing partnership shares compared to free shares, given the share price can go down as well as up.
Matching shares are a way for companies to reduce the cost of acquiring new SIP shares. For every partnership share purchased by employees, companies can issue matching shares without a cost to the employee. If a company decides to issue a matching share for every free share, the cost per share to employees is reduced by 50%.
Some companies may offer the chance for employees to be paid dividends from the free, matching, or partnership shares they own. As long as dividend shares remain in the SIP for three years employees won't have to pay tax, and national insurance is never due on dividend shares.
Like with partnership shares, employees who do leave the business within the three-year timeframe can still avoid paying income tax on dividend shares as long as they are classed as a 'good leaver'.
Share incentive plans and tax
There are a number of tax advantages available to both companies and employees through SIPs.
SIPs and capital gains tax (CGT)
Employees don't have to pay capital gains tax on SIP shares as long as the shares are still in the SIP, and there is no CGT due on withdrawal as long as the shares are exercised. However, if employees hold on to their shares after withdrawing them from the plan, they will have to pay capital gains tax on the difference between the share price at withdrawal and any appreciation that takes place after the withdrawal event.
SIPs and income tax
If the employee is a 'good leaver' under the terms of the SIP, they will not have to pay income tax or national insurance contributions (NICs). Likewise, if employees remain with the company for five years after being awarded shares, no income tax or NICs is due. Different companies may have different definitions of 'good leaver' and 'bad leaver', so employees should take care to check how their employer thinks about leaver clauses.
(Did you know? The UK government allows employees to transfer up to £20,000 from a SIP into an individual savings account (ISA) without tax being payable.)
Advantages of SIPs for companies
Let's sum up the different benefits of share incentive plans.
- Companies can claim tax deductions for the costs associated with running a SIP, and on the market value of any shares that are awarded. This makes a SIP a cost-effective share plan for companies to operate.
- Because the tax benefits of SIPs become more appealing the longer people stay at the company, SIPs can help retention and keep key employees motivated for longer.
- SIPs are designed to give equity to all employees. Distributing share ownership widely is a great way to empower all team members and ensure everyone shares in the gains from the company's success.
- SIPs – particularly free shares – can insulate employees from any ups and downs in the share price, as they cost nothing to acquire.
It's worth saying that while SIPs are a good fit for many companies, some companies may opt for different share schemes. SIPs only allow up to £3,600 of share purchases per employee each year, for example. Companies that are growing quickly and which have secured venture investment may find that EMI schemes allow them to give higher-value equity packages to employees.
Managing employee plans with Ledgy
SIPs are a simple way to offer share ownership to the whole company. Distributing equity to the whole team is a proven way to increase motivation and engagement – Ledgy's own research shows that nearly 90% of people with equity say their ownership makes a big difference to their motivation.
Ledgy's software gives companies best-in-class equity and cap table management, helping teams align behind a common goal.
Are SIPs only for private companies?
No! Any company – private or public – is able to set up and run a SIP for employees.
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