Share SchemesRisk management for lawyers and accountants

WINSLOWS.CO.UK

01 Quick Recap of the Benefits

Recruitment and Retention - Share plans are an important tool to recruit, retain and incentiviseemployees who are key for the growth and development of all businesses at all stages, especially for start-ups.

Increase Motivation and Output - Shares plans also assist in aligning the interests of the employees with those of shareholders, increasing employee engagement in the business and helping employees to feel invested in the success of the company.

Tax Efficiency - Most share plans, especially for private companies, are designed to provide tax efficient rewards to employees by delivering capital returns (which are taxed at a rate that is significantly less than employment income tax).

Reduce Costs - Employee share incentive plans can also reduce employment cost. and reduce pressure on cashflow when favoured over cash incentives.

No longer limited to the boardrooms of blue-chip companies, Share Plans have seen a dramatic rise in prevalence over the last two decades, fuelled in part by the UK’s new generation of start-up entrepreneurs, and the tax breaks created to encourage investment and business creation.

Share Schemes are booming. So, what’s the problem?

Well, like all markets, when demand increases so too does the pressure on service providers to meet that demand. Increasingly general practitioners (be they corporate lawyers or accountants) are being expected to provide specialist Share Schemes advice and documentation. And, whilst many Share Schemes concepts are relatively straightforward, the devil is in the detail, and with the increasing complexity of bespoke arrangements, the amount oferrors has started to rocket, exposing clients and their advisors to significant tax, commercial and professional negligence risks.

This brochure highlights some of the most common and potentially disastrous errors that must be safeguarded against. But first, it’s important to identify the types of schemes which can give rise to risks, but also the commercial and business events which utilise such schemes.

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Identify Share Schemes that carry risk.Share plans can broadly be divided into two categories, tax advantaged share plans (i.e. the tax advantages associated with these share plans are provided by legislation) and non-tax advantaged share plans (which may or may not be tax efficient, depending on the form).

Tax advantaged share plans (all product of specific legislation) are:

Enterprise Management Incentives (EMI)Company Share Option Plan (CSOP)Share Incentive Plan (SIP)Save as you earn (SAYE)

Non-tax advantaged share plans are::

Growth Share PlansJoint Ownership Share Plans (JSOP)Long term incentive plans (unapproved options, conditional share plan, cash bonus, Share appreciation right, etc)Partly-paid Share Plans

Each of the share plans listed above gives rise to specific risks that must be managed. See annexure for a summary of the most common plans.

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Identify Events involving Share Schemes and pinpoint risks

Start UpsWhile it is a no-brainer that most private start-up companies in the technology and innovation sector who qualify for the issue of SEIS/EIS shares would also qualify for EMI, dealing with the intricacies involved in EMI is not always all that simple. There are many technical aspects which need to be complied with and in our experience we have seen that there are innumerable instances where the EMI tax advantages were lost.

For example: design errors within the terms and conditionsdocumentation not compliant with legislation and HMRC guidanceshare valuations not properly obtained.

However, not all start-ups qualify for the grant of EMI options. There are many instances where non-EMI compliant companies have apparently granted EMI options only to find out that they do not qualify for the tax benefits.

It is essential to carry out technical analysis to determine that the company meets the EMI qualifying conditions and if required, seek advance assurance from HMRC.

Similarly, start-ups that do not meet the requirements of EMI may adopt a Company Share Ownership Plan “CSOP” if the qualifying conditions are satisfied. A CSOP is also very technical and given that HMRC do not approve CSOP documents any

more, the company is required to self-certify that all the conditions relating to CSOP legislation are met.

Typical errors include: incorporating non-essential featuresgranting options at less than market value both of which undermine the objectives of the plan.

In limited circumstances, other bespoke share plans like the Growth Share Plan or the Part-ly-Paid Share Plan may need to be implemented. Specialist advice should be sought on the design, drafting and implementation of such plans. In particular, it should be ensured that the returns are capital and do not give rise to the risk of income tax treatment.

Initial funding rounds and Management IncentivesWhile the initial funding rounds may not have a significant impact on the structure of the company as EIS shares are likely to be issued at these stages, share plans still play a vital role to recruit and retain employees, in particular, the key employees. Specialist advice should always be sought on the grant of new incentives to ensure that the returns are delivered in capital form from HMRC.

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1. START UPS

Private Equity & Corporate Reorganisations

Share Schemesand CorporateLife Cycle

Start Ups

Initial Funding Round

Management Incentives

Private Equity & Corporate Reorganisations

InstitutionalInvestors

Trade Exit

IPO

MBO

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Major funding rounds (Private equity and Institutional investment)As a company grows and develops, further funding is often required. At this stage, funding may be provided by a major investor like an institutional investor or a private equity house. Depending on the type and terms of the funding round, a change in corporate structure may be necessary with a new holding company being imposed on top of the company. As a result of such reorganisation, EMI (and where applicable, CSOP) options or other incentives may need to be ‘rolled over’ into the new parent company.

This is a highly technical area where numerous tax liabilities can be triggered if not implemented correctly. Specifically, advice should be sought on the roll over of options and other incentives and the design, drafting and implementing of any incentive package.

ExitMost private equity backed and institutional investor backed investments are geared for an exit so that the investors receive a capital return on their investments. Exit takes the form of an IPO or a trade sale or a partial trade sale, including management buy outs.

Specialist Share Schemes advice should be taken in respect of such exit process, for both the buyer and the seller (including the management team). The scope of specialist input may include:

advising on pre-exit strategies due diligence analysisadvising on the tax issues that arisetaxation aspects concerning the exittax clearancesform of consideration and its taxationtransaction in securities

Enterprise Management Incentives

Enterprise Management Incentives (EMI) are tax-advantaged share options designed to help small-er companies to recruit, retain and incentivise employees. EMI options may only be granted over shares in an independent trading company whose gross assets do not exceed £30 million and which has fewer than 250 employees. EMI options can be granted over a maximum value of £250,000 per person.

No income tax or national insur-ance contributions (NICs) are pay-able on the grant of an EMI option. Similarly, there is no tax or NICs liability when it is exercised, pro-vided that the exercise price is not set at a discount to the share price at the date of grant. If the exercise price is lower than the share price at the date of grant, there will be

an income tax and possibly a NICs charge on this discount at the time of exercise.

If certain “disqualifying events” occur, for example the company comes under the control of another company or ceases to carry on a qualifying trading activity, the EMI option must be exercised within 90 days of the event to preserve the favourable tax treatment.On sale of the shares, there is a potential for the gains to be taxed at 10% on the first £1 million of lifetime gains. The employing company can claim a deduction for corporation tax purposes for the difference between the market value of the shares at the exercise date and the amount paid by the employee. The employing company is exempt from employer’s NICs in the same way as the employee.

Popular Share Plans - Summary and key concepts

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Company Share Option PlanA Company Share Option Plan (CSOP) is a discretionary share option plan which allows the company to select which employees will be granted options and the size of award to be made to each individual, up to a limit of shares worth £30,000.

No income tax or national insurance contributions (NICs) are payable on the grant of a CSOP option or when it is exercised, provided that the exercise date is between the third and tenth anniversaries of the date of grant. No income tax arises on an earlier exercise in certain ‘good leaver’ circumstances.

On sale of the shares, there is a potential capital gains tax (CGT) liability at 20% on the gain.

The employing company can claim a deduction for corporation tax purposes for the difference between the market value of the shares at the exercise date and the amount paid by the employee.

Share Incentives Plans (SIPs) enable employees to acquire and hold shares in their employing company (or parent company) in three ways:

Timing of withdrawal

Up to £3,600 worth of shares can be awarded to employees each year

Partnership Shares Matching Shares

Employees can contribute up to £1,800 per year from pre-tax and NI earnings to buyshares

Companies can match each Partnership Share with Matching Shares

Timing of withdrawal

Within 3 years of award

Free Shares or Matching Shares

Partnership Shares

Market value of shares when they are withdrawn

Market value of the shares when they are withdrawn

When shares are withdrawn from the SIP, there will be income tax liability on the following amounts:

Dividend Shares

The amount of the dividend used to acquire shares

Save As You EarnA Save-As-You-Earn (SAYE) share option scheme combines a share option with a savings contract, so employees can save the funds to buy shares in their company.

No income tax (or NICs) is payable on grant of the option. No income (or NICs) is payable on exercise of the option (except in certain exceptional circumstances).

On disposal of the shares there is a potential capital gains tax (CGT) liability on the difference between the market value of the shares on disposal and the price paid for the shares.

There is no tax on any bonus payable through the savings contract.

The employing company can claim a deduction for corporation tax purposes for the difference between the market value of the shares at the exercise date and the amount paid by the employee.

Growth Share Plans Growth Shares are a special class of shares which participate in the growth in value of a company in excess of a predetermined threshold. Typically on

‘exit’, a sale of the company or a winding up it only has rights to any value realised once the existing other ordinary shareholders have received back a predetermined amount. This predetermined amount will typically be “the market value” of the ordinary shares at the time that the relevant class of growth share is issued, often plus a hurdle rate of return.

Gains made on the increase in value of the Growth Shares on their eventual disposal are subject to capital gains tax. CGT on the disposal of shares is charged currently at 20% for a high-er rate or additional rate taxpayer after the annual allowance (currently £12,300) and any other available re-liefs. For basic rate taxpayers, the rate is 10%.

However, income tax (and NIC) will arise on the acquisition of the Growth Shares based on the value of the shares unless an amount equal to their full market value is paid by the employee at the time of acquisition. In normal situations, it is unlikely that the tax charge will be significant as the tax will in effect be based on the ‘hope’ value of the shares, which one can usually argue is very low.

Between 3 and 5 years

Lower of market value at award date and at withdrawal

Lower of money used to acquire shares and when they are withdrawn

No charge

5 years or longer No charge No charge No charge

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Enterprise Management Incentives (EMI);Company Share Option Plans (CSOP);Share Incentive Plans (SIP);Save As You Earn (SAYE);Growth Share Plans;Joint Share Ownership Plans (JSOP);Unapproved Option Plans;Conditional Share Plans;Cash bonus arrangements;Share appreciation rights;Party Paid Share Plans;

Winslows offers Specialist Share Schemes support on the design, drafting and implementation of the following plans

Winslows Share Schemes - Services Menu Become a Partner

Firm And add a Share Schemes Capability to your team.Winslows offers its clients a unique Tax Support function including share schemes specialists, that can work alongside your team adding expert capability and enabling bigger and better transactions to be handled by your firm.

Get StartedFor more information on Share Schemes or general Tax Support, or to confirm whether your practice is suitable for Winslows Partner Firm arrangement, please contact our London Head Office

020 3196 5582 info@winslows.co.uk

DisclaimerThe information contained in this brochure is for information purposes only and should not be used to replace the need to obtain tax advice. The information is provided by Winslows Tax Law Limited and whilst we endeavour to ensure the information up-to-date and correct at the time of distribution for illustrative purposes, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the brochure or the information, products, services, or related graphics contained in the brochure for any purpose. Any reliance you place on such information is therefore strictly at your own risk.

In no event will we be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of or in connec-tion with the use of the information on this brochure. Winslows Tax Law Limited is a company registered in England and Wales, Company Registration No. 105662246, the registered office of which is at 1 Vicarage Lane, Stratford, London E15 4HF. Winslows Tax Law is Authorised and Regulated by the Solicitors Regulation Authority. A list of Directors is available from its registered office.

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