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WHAT TYPE OF SCHEMES ARE THERE?
 Approved or Unapproved Schemes
The most fundamental distinction to be drawn is between “approved” schemes and “unapproved” schemes. The difference between the two is that the government offers tax incentives to approved schemes, which makes them far more desirable for both employer and employee. At the same time, the government has imposed regulations and restrictions to control how these schemes are operated.
Unapproved schemes do not have official requirements as to how they are operated – the scheme rules can be whatever the employer wants them to be. This freedom is paid for by the absence of tax incentives. The fact that a scheme is “unapproved” does not mean that the Inland Revenue is opposed to its being used, merely that there are no tax breaks on offer for using it!
On the whole, however, the value of the tax breaks on offer means that it would be wise to consider only approved schemes as worthwhile. The range of approved schemes available at present is sufficiently broad to allow a variety of different approaches.
Share Schemes or Option Schemes
One important way in which schemes differ lies in what exactly the employee receives. In some schemes (“share schemes”), the employee receives shares in the company, while in others (“option schemes”) he receives options enabling him to purchase shares.
What exactly is the difference? With a share scheme, the employee receives shares on day one. These are usually fully paid-up shares, the employee is able to keep them or sell them as he pleases, and he has an immediate right to receive dividends.
With an option scheme, on day one the employee receives a call option. This is the legally enforceable right to purchase shares in the company at some specified future date (the “option date”) for a specified sum of money (the “option price”). For example, the employee might be given on 1 January 2003 an option enabling him to purchase, at any time in 2005, up to 100 shares in the company for £5.00 per share.
The advantage of an option is flexibility and choice: if, by the option date, the market value of the shares has risen to £10.00, the employee can choose to purchase them for what is effectively half price. Equally, if the market value has dropped below the option price, the employee need not exercise his option – he is protected from the risk that the shares lose value.
The main drawback is that, from the time he receives the option to the time he exercises it, the employee owns nothing but the option, an asset that may have little intrinsic value. He is not a shareholder. He will not be able to receive dividends until he has exercised the options and purchased the shares. In addition, the employee needs to purchase the shares, which means that he must lay out some money. Most option schemes address this last issue by incorporating either a parallel savings scheme or a partial sellback scheme, which ensures that the employee does not need to go out of pocket to exercise his option.
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Parallel Savings Scheme |
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A parallel savings scheme is designed to enable the employee to set aside a small amount of cash every month. These deposits, together with accrued interest, will mount up, over the period between the grant of the option and its exercise, to the amount needed to purchase the shares.
For example: Alan is granted on 1 January 2003 an option which may be exercised at any time between 1 January and 31 December 2005. The option enables him to purchase 100 shares for £5.00 per share.
The full cost of exercising the option is £500, and the shortest period in which it can be exercised is 24 months. Alan saves £20.50 a month into a parallel savings scheme. By 1 January 2005, he will have saved £492, and will have earned around £8 of interest. When he exercises his option, he will have the necessary funds available. |
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Partial Sellback Scheme |
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A partial sellback scheme is designed to provide a market for shares on the option date, so that an employee can sell some of the shares he obtains from exercising the option and use the proceeds to fund his overall purchase.
For example, Bill receives exactly the same option on 1 January 2003 as Alan. Instead of a savings scheme, he is offered a partial sellback.
On 1 January 2005, Bill discovers that the company’s shares have risen in value to £14.00 a share. He needs to find £500 to exercise his option and purchase 100 shares. At £9 a share, this means that 36 of the 100 shares need to be sold to realise the £500 exercise cost – in fact, selling 36 shares will realise £504.
At the end of the day, Bill is left with 64 shares, plus the odd £4.00 (less any dealing costs). |
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