Implementing a share plan

In principle, non-statutory schemes can normally be set up within two or three weeks if necessary. However, it is not uncommon for the process to extend over several months. The company may have to consider the implications of a proposed scheme in terms of its future growth plans, possible exit strategy and capital structure. This may require internal deliberations and meetings of the Board and/or shareholders.

If a company wishes to operate a Share Incentive Plan, Approved CSOP Scheme or Approved SAYE Option Scheme it must first obtain approval from HM Revenue & Customs.[105] This will also extend the timescale. 

Approval by HM Revenue & Customs

The authorities will require copies of:

Applications are handled by the Employee Shares and Securities Unit in London which currently works to a four-week turnaround of correspondence, although some scheme examiners are noticeably quicker than this. The effect of this system is that if an examiner raises a query on a scheme document – and the query can be minor, such as a missing capital letter in a defined term – a further significant period of time may elapse before the corrected documents have been processed. 

In the case of options under the Enterprise Management Incentive, a notice of grant is completed and forwarded to HM Revenue & Customs for registration. This must be lodged within 92 days of the date of grant. It is no longer necessary to submit the option agreement, scheme rules, articles of association or shareholders’ agreements but HM Revenue & Customs may call for these documents if they choose to inspect the scheme.

Anti-avoidance disclosure

Advisers are required to notify HM Revenue & Customs of any employee share arrangements they set up where one of the main benefits is a tax advantage and the scheme falls within one or more descriptions (known as “hallmarks”) set out in the regulations. Primary legislation was published in the Finance Bill 2004 and (at the date of writing) has since been supplemented by 9 sets of Statutory Instruments. HM Revenue & Customs has periodically published guidance the last of which (August 2006) was almost immediately corrected by “Update 1”.

Despite the volume of regulation and guidance, there is uncertainty about what is meant by “main benefit” and “tax advantage”. Some practitioners take the view that, to be on the safe side, any arrangement which is not specifically permitted by the regulations and where there is any kind of tax mitigation should be disclosed, even if the arrangements are not designed to produce an artificial result. 

The “hallmarks” referred to above are:

There are a number of exceptions to the “standardised” hallmark. These include the use of various government regulated arrangements such as the enterprise management incentive scheme, venture capital trusts, corporate venturing schemes, registered pension schemes, ISAs, and all the government approved employee share schemes.[112] The Enterprise Management Incentive is technically a regulated, not an approved scheme, but use of this scheme is also excepted as long as all the features are either “reasonably necessary” for the purposes of the scheme or are reportable to HMRC under the EMI regulations.

Notification must be made within 5 days of the earlier of explanatory documentation being provided to the client or the transaction taking place, except in the case of internally generated schemes where the time limit for disclosure is 30 days. Any particular arrangement needs to be disclosed only once, to the Anti-Avoidance Group (AAG) of HM Revenue & Customs. The AAG will issue a reference number which must be reported on a form AIU4 before the 19th May following the end of the tax year in which the benefit is first expected to arise. It must be reported again each year for as long as the benefit is expected to continue.[113]

Where a PAYE benefit will arise, the report will be made as part of the P35 return from 2006/07 onwards. Any corporation tax benefits are recorded on the company’s annual tax return and if a trust is involved, on the trust self-assessment return. Separate reporting requirements apply to non-employment tax planning arrangements.

In cases where the adviser is outside the UK, or is a lawyer and legal privilege applies, or where the idea is developed internally, the liability for reporting the arrangement falls on the company. Penalties of up to £5,000 and £600 per day are provided for non-disclosure.

It should be emphasised that the requirement to report an arrangement to the AAG does not mean that the arrangement is abusive or unacceptable. However the purpose of the legislation clearly is to flush out aggressive tax avoidance schemes and the Government has powers to disallow any arrangements that it considers abusive with retrospective effect to December 2nd 2004.

Adapting foreign schemes

Many foreign parents of UK companies already offer employee share schemes. In general, foreign schemes cannot enjoy tax advantages under UK regulations. In some circumstances, however, statutory arrangements can be established in the UK that reflect at least some of the terms of an existing foreign scheme.

Where the parent company is a US company, a common pattern is for employees to be offered:

UK Parallels

A stock option plan may be mirrored to some extent by a tax-efficient UK scheme. Many foreign parents will be too large to take advantage of the Enterprise Management Incentive. However the Approved CSOP Scheme may be a possibility. The major difference between this and a typical US scheme will be the minimum period to exercise, which in the UK is three years. However, UK management often takes the view that a three year “vesting” period is more effective in terms of retaining and motivating staff than the staged, two year vesting period common in the US. Overlapping option schemes can also be used under a statutory UK scheme, as long as the total value of shares granted to any one individual does not exceed the £30,000 limit.

A stock purchase scheme can be mirrored in part by an Approved SAYE Option Scheme or the share purchase provisions of a statutory Share Incentive Plan. In the latter case, the “discount” can be seen as analogous to the “saving” that results to the employee in being able to purchase from gross income. An additional discount can be provided by means of Matching Shares. However, the £1,500 per annum statutory limit for share purchase under a Share Incentive Plan is too small to interest most US parented companies.

More relevant is the Approved SAYE Option Scheme. This has a higher saving limit of £3,000 per annum and employees may acquire shares at a discount of up to 20 per cent. to fair value at the date of grant. Overlapping SAYE schemes may be offered, thus creating a “rolling benefit”, as long as statutory savings limits are not exceeded in any one year. Once again, the minimum three-year exercise period is usually not seen as a major disadvantage by UK management.

Finally, a deferred purchase scheme may be considered. This defers the total cost of ownership for the employee, and ultimate gains should be subject to capital gains tax rather than income tax.

Non-domiciled employees

A foreign parent may wish to incentivise staff that are resident in the UK and paying UK income tax, but not domiciled in the UK. Such individuals are taxed on a remittance basis, that is, on such portion of their worldwide income as they choose to remit to the UK. By international standards this treatment is generous. Although the policy is regularly reviewed by HM Treasury, it has never been overturned, presumably because of the risk that large numbers of high net worth individuals would then leave the UK.

It is not uncommon for a multinational group to offer loyalty incentives to staff, or make payments in respect of services not performed in the UK. Where such payments genuinely do not arise from UK employment, and where they are not remitted to the UK, they may be held offshore without liability to UK tax. It is important that offshore funds are not mingled with onshore funds. Normally, the trust will be managed by discretionary trustees, guided by means of a non-binding letter of wishes supplied by the settlor of the trust, or even potential beneficiaries. Care must be taken to ensure that a potential beneficiary observes the relevant tax rules in his or her own country of domicile. For example, failure to disclose an interest in a discretionary trust is a serious offence for a US citizen.

Employee communication

Employee share schemes are used to help recruit, retain and motivate staff. However if the scheme is to be effective then the nature of the arrangements and their potential benefits must be properly understood and appreciated by the employees.

The way in which this is done will depend on the individual company and on the nature of the scheme. The communication effort required for an all-employee scheme will clearly be on a larger scale than that required for the issue of options to one or two selected employees.

Depending on the nature of the scheme, some of the following techniques will normally be relevant. All documents to be supplied to employees in the context of a Share Incentive Plan must be submitted to HM Revenue & Customs as part of the approval process. In other cases the documents need not be submitted but they should carry a statement to the effect that in the event of any conflict the scheme rules and legislation take precedence and references made to taxation consequences are for guidance only (see further below in relation to the Financial Services and Markets Act 2000).

A publicity campaign

For all-employee schemes, in particular, it may be helpful to build interest and excitement through posters, flyers, payslip inserts etc. perhaps using techniques such as slogans and even cartoon characters. Some of these campaigns can be very creative and attractive. However, it is important to avoid overkill – employees do not like to feel they are being patronised. 

The company may also consider making one or more press releases, or persuading a local paper to run a feature about the scheme. This may have the incidental benefit of attracting potential employees.

If the company publishes an internal newsletter, this will provide an obvious opportunity for publicising the scheme.

Explanatory literature

This should contain the main terms of the scheme and explain its benefits in accessible language. The skills of the workforce will need to be taken into account, and the use of specialist accounting or legal terms should be avoided in most cases. However, the documents must be technically accurate. They will also need to include certain statutory declarations, depending on the nature of the scheme(s) being introduced. Professional advice should be sought.

Face to face presentation

Face to face meetings are often the most effective communication method. In a share option scheme there may be only a handful of recipients, in which case individual presentations can be made.

For large option schemes, or all-employee share schemes, group presentations will be required. A good audience size for each session is 20 to 30, since this allows those who have genuine questions to ask them but reduces the chances of a single member of staff monopolising the proceedings. The initial presentations should be made to the senior staff, so that they are in a better position to answer any questions put to them later by more junior staff. Senior staff will also tend to act as “opinion formers” within the organisation. If the presenters include an outside person – perhaps a representative of the scheme designers – employees may feel that the whole exercise is more genuine. This will also ensure that any technical questions can be given a full answer.

Intranet/extranet sites

Software is now available which allows employers to post share scheme information on the internal computer network, or on an external website. Employees are issued with passwords so that they can access their personal details. Some software allows employees to experiment with “what-if” scenarios, for example to see the value of their share options under different assumptions about the likely flotation or sale value of the business.

Continued communication

Whatever the methods chosen, the employer should make plans to reinforce the message at regular intervals. Good opportunities for this are when dividends are payable on shares held in trust, when shares are revalued prior to a further allocation, or on finalisation of the audited accounts. At these times the employer can arrange employee meetings and use the opportunity to reinforce company messages generally.

Employees who own company shares are entitled to receive the company’s report and accounts each year. Holders of share options are not so entitled but there would seem to be few arguments against their receiving the accounts since a purpose of the share option scheme will normally be to focus employee attention on the performance of the company. The accounts they receive need be no more detailed than those available on the public record at Companies House.

Securities regulations

Financial Services and Markets Act 2000

In general terms the Act seeks to ensure that those carrying out investment activities should be authorised to do so under the terms of the Act, unless the activities themselves, or the persons involved in them, fall within one or more of the exemptions provided. [114] Activities specified include:

Fortunately employee share schemes are excluded from the definitions of all the above activities. For these purposes employee share schemes are defined, in summary, as arrangements made to facilitate the holding of, or transactions in, investments in the sponsoring company for the benefit of employees, former employees and their families. Care should be taken in relation to activities that are not part of an employee scheme, such as the grant of share options to a non-employee, or where the operator of the scheme is not the company itself or the trustee of the employee scheme. 

Similarly, care is needed in relation to communications issued to non-employees, or by persons who are not officers of the company (or a group company) or the trustee of an employee share scheme. These communications are likely not to be exempt unless other exemptions are available such as those for “sophisticated” investors or those with “certified high net worth”. Exemption may also be available if the offer of securities is a one-off exercise which is not part of a general marketing campaign. A detailed description of these exemptions is beyond the scope of this Guide.

None of the above exemptions apply to the provision of investment advice, which is a regulated activity under the Act. When explaining share schemes to prospective participants, employers and/or trustees should avoid making statements that could be construed as recommendations to participate. Explanatory documentation should include wording along the following lines:

[company/issuer] cannot and does not advise you on whether you should participate in the arrangements set out in this [memorandum]. The value of shares in [company] can go down as well as up. [(if applicable) There is currently no public market for the shares in [company] and you may not be able to realise all of the value of any shares you acquire]. If you require advice on whether or not to participate you should consult an adviser duly authorised under the Financial Services and Markets Act 2000.

Offers of shares to the public must normally comply with the Public Offer of Securities Regulations 1995, based on European Union Directives. Documentation issued to employees in connection with an employee share scheme will normally be exempt from these requirements. However it is an offence (under the Financial Services and Markets Act 2000) to make misleading statements or to conceal material facts in connection with the promotion of an employee share scheme, even if these statements do not themselves constitute a recommendation to invest.

UK Listing Authority regulations

The Authority’s Listing Rules contain a model code for dealings by employees in their own company’s shares. The code requires that “restricted persons” (being directors, senior managers, persons with inside information and anyone connected with them) should not normally deal in company securities during a close period (usually 60 days before the announcement of results – see Glossary). “Dealing” includes not only the acquisition or disposal of shares but also the grant or exercise of share options. This is subject to certain exceptions.[115] Restricted persons wishing to deal outside close periods must obtain clearance to do so.[116] Dealings by directors in their own company shares must be reported to the company in accordance with section 324, Companies Act 1985; additionally, all dealings by restricted persons must be reported to the London Stock Exchange within 5 days.

The rules of the Alternative Investment Market follows the general spirit of the Model Code in prohibiting dealings by directors or “applicable employees”,[117] during close periods but allow for no exemptions apart from dealings that are necessary to alleviate severe personal hardship. 

The AIM rules provide that if a company’s main activity is a business which has not been independent and earning revenue for at least two years as at the date of admission, then any employee who might have price sensitive information, or who has an interest of 0.5 per cent. or more of the share capital, must agree not to dispose of any interest in the company’s securities (including the exercise of any options) for one year from the admission of its securities.

European Prospectus Directive

The EU Prospectus Directive (“the Directive”) came into effect on December 31, 2003 and implementation by each EU member state is effective from July 2005. The Directive is intended to allow companies to use a single prospectus for all public offerings in member states.

In the past UK companies in the UK have not been required to issue investment prospectuses in relation to employee share schemes. This broad exemption is not available under the Directive. However there is an exemption from the requirement to issue a prospectus if the total consideration of the offer is less than €2,500,000. Various other exemptions are available but may not be relevant if the offer exceeds €2,500,000. These include where:

If exemption is available, the employer should nevertheless issue a summary of the background to, and reasons for the offer and the nature of the securities being offered.

Some practitioners take the view that, since the Directive applies only to transferable securities, it cannot apply to unquoted shares. We are cautious about this interpretation especially if the company has arranged for any sort of matched bargain or internal market for the shares. The Financial Services Authority has stated that the Directive does not apply to the issue or the exercise of employee share options, presumably on the grounds that an employee option is not normally transferable.

[105] This does not apply to the Enterprise Management Incentive, which requires a registration process rather than approval.

[106] Except in the case of a Share Incentive Plan, trust documents must also be registered with HM Revenue & Customs on form 41G.

[107] In the case of the Share Incentive Plan only, the employee documents must include a notice warning that salary deductions for Partnership Shares may affect the individual’s rights to certain benefits, particularly if their income falls below the lower earnings limit for national insurance. In the case of SAYE schemes, documents circulated to employees will include a share save application from the relevant savings carrier and a savings prospectus.

[108] This includes the requirement that if the Articles of Association give the directors the power to refuse the transfer of a share they will not use this power to the disadvantage of any scheme participant, and that the employees have been so informed (this notification is normally included in a footnote to the employee documents).

[109] Defined as where the price of the financial product “differs significantly from that which might reasonably be expected to apply in the open market upon its being, or their being, made available to the other party when compared with a product that is… substantially similar to the product … in question.”

[110] Arrangements designed with little customisation for individual clients. There are a number of exceptions including arrangements using the following: venture capital trusts, qualifying corporate venturing schemes, ISAs, Approved Share Incentive Plans, Approved Company Share Option Plans

[111] That is, schemes designed to produce losses which can be set against taxable profits.

[112] The Approved Share Incentive Plan, the Approved CSOP Scheme and the Approved SAYE Share Option Scheme.

[113] According to guidance issued by the Anti-Avoidance Group, if a form AIU4 is submitted by the employer then the employees participating in the scheme do not have to report the anti-avoidance reference number in their personal tax returns, although this fact is not mentioned on the return itself.

[114] Persons authorised under the provisions of Part IV of the Financial Services and Markets Act 2000 include most firms of accountants and lawyers, who had the opportunity to automatically gain authorisation under “grandfathering” provisions contained in the Act, plus other individuals and firms who have applied directly to the FSA and have satisfied complex requirements in terms of capital adequacy, expertise, management, training and other factors.

[115] These include (broadly speaking) transactions that are essential to avert severe personal hardship, participation in a rights issue, accepting a takeover offer, transactions with close relatives, transfers of shares into saving schemes, exercise of SAYE options, the cancellation of options and the acquisition (but not sale) of securities pursuant to an employee share scheme approved by HM Revenue & Customs.

[116] A director must obtain clearance from the chairman or designated director, the chairman from the chief executive (or, if this is the same person, from the Board) and other restricted persons from the company secretary or designated director.

[117] A person who holds directly or indirectly 0.5 per cent. or more of a class of AIM securities (excluding treasury shares) or is likely to be in possession of unpublished price-sensitive information in relation to the AIM company because of his or her employment in that company, its subsidiary or parent undertaking.