Implementing a share plan

In principle, non-statutory schemes can 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, CSOP Scheme or SAYE Option Scheme it must first obtain approval from HM Revenue & Customs.1 This will also extend the timescale.

Approval by HM Revenue & Customs

The authorities will require copies of:

the memorandum and articles of association, together with any shareholder agreements;
the rules of the scheme;
where a trust is involved, the executed deed of settlement;2
all documents to be circulated to employees, including the relevant letters of offer, acceptance/ application forms and certificates;3
declarations of the company to the effect that the company, the scheme and the shares to be used for the scheme comply with certain relevant sections of the legislation;4
a completed questionnaire containing operative dates, company and contact information and details of the company's PAYE and corporation tax offices and reference numbers, including those for any participating subsidiaries; and
certified company or Board resolutions adopting the schemes.

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, even on a minor issue such as incorrect capitalisation, 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 or NICs advantage and the scheme falls within one or more descriptions, known as "hallmarks", set out in the regulations. Primary legislation was contained in the Finance Bill 2004 and has been supplemented by Statutory Instruments. HM Revenue & Customs has also issued guidance the most recent of which was in August 2006. NICs were incorporated into the regime by statutory instrument in 2007.

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:

wishing to keep the arrangements confidential from a competitor;
wishing to keep the arrangements confidential from HM Revenue & Customs;
arrangements for which a premium fee could reasonably be obtained, even if in fact it is not obtained;
schemes that include "off market terms", defined as where the price of the financial product is significantly different to that which might be normally expected - the implication being that there is some cross-subsidy being paid in respect of the tax avoidance aspects.

Other hallmarks are "standardised" tax products;5 "loss schemes";6 and certain leasing arrangements.

There are a number of exceptions to the hallmarks. These include the use of various government regulated arrangements such as the Enterprise Investment Scheme, venture capital trusts, corporate venturing schemes, registered pension schemes, ISAs, and all the government approved employee share schemes.7 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 (i) explanatory documentation being provided to the client or (ii) 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 by the employer on a form AIU4 before the 19th May following the end of the tax year in which the benefit is first expected to arise.8 It must be reported again each year for as long as the benefit is expected to continue.9

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.

Rulings and guidance from HM Revenue & Customs

In a small number of specified circumstances, it is possible to apply to HM Revenue & Customs for advance clearance that a proposed transaction will not suffer adverse tax treatment. Such occasions include the roll-over of capital gains tax liability on a share for share exchange or the purchase by an unlisted company of its own shares. It is also possible to apply for clearance that HMRC will not seek to take action to counter any income or corporation tax advantage arising from a proposed transaction under general anti-avoidance principles.

Additionally, HM Revenue & Customs sets out in its Code of Practice 10 a number of ways in which tax payers and their advisers can seek information and guidance. A considerable amount of information is disseminated through leaflets, newsletters and the publication of internal manuals (for details see the Contacts section). HM Revenue & Customs is also willing to provide "general advice" on tax issues, although the emphasis here is normally on the "general". Through its "open government" policy, HMRC will provide information on policy decisions it has previously made, although in some cases it will make a small charge.

In relation to specific transactions, HM Revenue & Customs may provide a ruling after the transaction has occurred, but only when there is genuine uncertainty as to how the relevant tax law will apply. Such rulings are normally binding on HM Revenue & Customs unless it has not been fully informed of the circumstances. Additionally, HM Revenue & Customs may be prepared to provide guidance ahead of a transaction where there is real uncertainty in relation to the interpretation of tax law and this relates to:

legislation passed in the last four Finance Acts ;
the application of double taxation agreements;
whether someone is employed or self employed;
statements of practice and extra-statutory concessions; or
other areas concerning matters of major public interest in an industry or in the financial sector.

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:

a "stock option" plan, where the number of options that the employee can exercise within the total granted to him or her will increase in stages over say a two year period; and/or
a "stock purchase" plan, under which the employee may commit a certain part of salary to the purchase of stock, often at a discount of 15 per cent. to market value.10

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 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 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 statutory limit per tax year for share purchase under a Share Incentive Plan is too small to interest most US parented companies.

More relevant is the SAYE Option Scheme. This has a higher saving limit of £3,000 per tax year 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.

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

Non-domiciled employees

In certain circumstance, an employee who is resident but not domiciled in the UK can receive benefits offshore. Examples might include payments for services performed during periods abroad, or loyalty incentives offered by a multinational group which are reserved for the employee in an offshore fund.

From 6th April 2008 a person who is resident but not domiciled or ordinarily resident 11 in the UK must pay tax on their world-wide earnings 12 whether or not remitted to the UK,

unless:

the person has been resident in the UK for less than seven of the preceding nine tax years or is under 18, or;
the person elects to pay tax only on foreign income and gains remitted to the UK, plus a fixed charge of £30,000 per annum (the "remittance basis").13

The same treatment applies to employee share scheme benefits arising overseas. However, any UK national insurance contributions payable on overseas share scheme gains by a non-domiciliary must be paid in full. Additionally, HM Revenue & Customs takes the view that, regardless of whether the remittance basis has been chosen, any gains arising in relation to the shares of UK companies will be regarded as remitted in full for UK tax purposes.

Non-domiciled residents often use offshore trusts to hold income and assets that have been acquired outside the UK tax net. It is important that funds acquired outside the UK tax system are not mingled with funds which may be subject to UK tax.

Care must be taken to ensure that a potential beneficiary of an offshore trust 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 participants.

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.

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.

A publicity campaign

For all-employee schemes, in particular, it may be helpful to build interest and excitement through posters, flyers, payslip inserts and similar methods. 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 who issue any "invitation or inducement" to invest in securities should be authorised to do so under the terms of the Act. Authorised persons include most firms of accountants and lawyers.14 Other authorised persons include 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.

In addition to simple invitations to invest, the legislation covers situations such as:

making arrangements for the buying, selling or subscribing for company shares;
holding investments on behalf of other people including the operation of collective investment schemes.

Employee share schemes are excluded from these provisions. These schemes are defined in the Companies Acts 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 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, a group company or the trustee of an employee share scheme. Exemptions are available for invitations to existing shareholders or in relation to a company sale.15 Exemptions are also available if the investor(s) can be said to fall into one or more of the following categories:

"Certified high net worth": broadly, the investor must have certified an annual income of not less than £100,000 or net assets to the value of not less than £250,000. The requirements are subject to detailed conditions. Associations of these investors may also qualify, as may high net worth companies.
"Common interest group": the investors must be able to demonstrate a common commercial interest with the company and each other, which extends beyond their status as potential investors. The documentation must contain certain "health warnings".
"Sophisticated": the investor must produce a statement from an authorised person stating, inter alia, that the person is sufficiently knowledgeable to understand the risks involved. The individual must also sign a disclaimer. Alternatively an individual can self-certify by signing a statement in a prescribed form which shows that they have previous investment experience or experience as a director of a company with a turnover exceeding £1 million. Associations of investors can also qualify as sophisticated.

The "certified high net worth" and "common interest group" exemptions apply only if the offer of securities is either solicited by the prospective investor or is a part of a general marketing campaign which does not involve targeted personal visits, telephone conversations or other dialogue.

None of the above exemptions apply to the provision of investment advice. 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.

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 certain individuals in their own company's shares. The code requires that "persons discharging management responsibilities" ("PDMRs") should not normally deal in company securities during a "prohibited period", being a time when there exists any matter which constitutes unpublished, price sensitive information in relation to the company, or a close period. They should also not deal on considerations of a short term nature. "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.16

PDMRs wishing to deal outside prohibited periods must obtain clearance to do so.17 Dealings by directors in their own company shares must be reported to the company in accordance with the Companies Act; additionally, all dealings in listed shares by PDMRs must be reported to the London Stock Exchange within 5 working days.

There are certain exceptions for PDMRs who are also participants in employee share schemes. These include the exercise of SAYE options, the cancellation of options, the acquisition - but not sale - of securities pursuant to a Share Incentive Plan and the transfer of shares from a Share Incentive Plan or following SAYE exercise into a savings plan such as an ISA.

Employees who are not PDMRs but are in possession of price sensitive information and deal in their employer's securities are subject to general criminal and civil market abuse prohibitions and criminal insider dealing prohibitions.

The rules of the Alternative Investment Market follows the general spirit of the Model Code in prohibiting dealings by directors or "applicable employees",18 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 "applicable employee" 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 in the UK is effective from July 2005. The Directive is intended to allow companies in the EEA to use a single prospectus for all public offerings in member states.

In the past UK companies 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 €2,500,000.19 Various other exemptions are available, including when:

the shares are quoted on an EEA recognised exchange;
the offer is to fewer than 100 participants in each member state;20 or
the denomination per unit of investment is at least €50,000.

If exemption is available because the shares are listed, the employer should nevertheless issue a summary of the reasons for, and details of the offer and the number and nature of the securities being offered.

The UK Financial Services Authority has stated that the Directive does not apply to the issue or the exercise of employee share options, on the grounds that an employee option is not normally transferable. It is also not applicable in relation to shares gifted to employees since there is no consideration.21 Interpretation of the Directive varies across EEA member states and local advice should always be sought.

Investment communications are also subject to the Financial Services and Market Act 2000. It is an offence under the Act 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.

This does not apply to the Enterprise Management Incentive, which requires a registration process rather than approval.»
Except in the case of a Share Incentive Plan, trust documents must also be registered with HM Revenue & Customs on form 41G.»
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.»
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 the explanatory documents circulated to employees).»
Arrangements designed with little customisation for individual clients.»
That is, schemes designed to produce losses which can be set against taxable profits.»
The Approved Share Incentive Plan, the Approved CSOP Scheme and the Approved SAYE Option Scheme.»
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.»
At the time of writing new regulations were being proposed to make it possible for schemes that have been registered with AAG to be de-registered.»
These often take the form known as a 423 Plan. Employees agree to save from taxed income over an offer period which can be from 3 to 27 months but is usually 12 months. They use these savings to buy shares - or can ask for a cash refund. They pay either the price at the start of the offer period, or the lowest of the price at the start or the end of the period (depending on scheme design), and may also be offered a discount of up to 15 per cent. The discount is taxed as income on sale of the shares, but any other gains are taxed at low capital gains tax rates provided that at least two years have elapsed since enrolment and the employee has held the shares for at least one year.»
For brief descriptions of these terms, see Glossary.»
Unremitted income of £2,000 per annum or less may be left outside the UK tax net without triggering the £30,000 charge. »
Choosing the remittance basis will also result in the loss of UK personal income tax and capital gains tax allowances.»
Many such firms had the opportunity to gain authorisation automatically under "grandfathering" provisions.»
At the time of writing this exemption was being reviewed.»
These include (broadly) transactions that are essential to avert severe personal hardship, participation in a rights issue, accepting a takeover offer and transactions with close relatives.»
A director must obtain clearance from the chairman or a director or committee designated by the Board. The chairman must obtain clearance from the chief executive or in his absence, senior non-executive director or a committee of the Board or other director nominated by the chief executive. The chief executive must likewise obtain clearance from the chairman or in his absence, senior non-executive director or a committee of the Board or other director nominated by the chairman. If the chairman and the chief executive are the same person they must obtain clearance from the Board.»
Broadly, a person interested in 0.5 per cent. or more of a class of AIM securities or likely as a result of employment duties to be in possession of unpublished price-sensitive information.»
Offers made in any EEA state over the previous 12 months are aggregated for the purpose of this test.»
This limit applies to each offer so an issuer may make as many offers as it wishes to not more than 99 staff members.»
This may not apply in cases where shares are offered as an alternative to other benefits such as a cash bonus. In some EEA states the exemption may not be available at all, due to different interpretations of the Directive.»