Red, White and Blue - Options on either side of the Atlantic

Posted by admin at 15:51 on 13 Feb 2017


In keeping with the red, white and blue of this month's Jubilee celebrations we at RM2 thought we would highlight some matters regarding share options for companies expanding their operations across the pond.
Those watching the Jubilee celebration concert will have noticed that some of the American artists seemed to have been badly informed, mistakenly referencing celebrating the Queen's birthday whilst the rest of us were celebrating the anniversary of her coronation. This was just another example of how easy it is to make a faux pas as a foreigner abroad.
When looking at the issue of share options in the UK and USA, the treatment, particularly tax treatment, could not be more different. Listed below are a few common complications to watch out for:
1) Awarding overseas employees options under the UK approved EMI Scheme.
If awards are made under an Enterprise Management Incentive (EMI) plan to US employees the options are treated as unapproved share options and thus do not qualify for the same tax advantages as in the UK. Under EMI, the total value of shares over which options can be granted is currently £3 million. Therefore, it is not advisable to grant options to US participants under the EMI plan as these options would be included within the aforementioned limit, but without the tax advantages. This would not, however, apply to UK employees who have been seconded to the US for a short period of time and are then returning to the UK prior to their exercise of the options. In this situation, an EMI award could still prove to be beneficial.  If the proposed participant is permanently based in the US or will not be returning prior to the date of exercise, consider a qualifying US stock option plan or a UK Unapproved Share Option Plan (USOP) rather than EMI for awarding equity to these individuals.
2) The dilemma of the exercise price.
There are specific obstacles to address when considering awarding options to US employees over unquoted stock. In order to secure the most attractive incentive for employees and maximise the headroom for the number of shares over which options may be granted within the EMI limits (currently £120,000 per individual but rising to £250,000 from 16th June 2012 and £3 million in total [the £3m overall limit is not increasing on 16 June]), it would be desirable to negotiate an agreement with HMRC SAV for a relatively low share value. Whilst this should be possible in respect of UK employees, it will not be advisable or possible to secure the same stock value discount agreement with the IRS for US employees due to US legislation. The issues relating to the treatment of unquoted US stock options are outlined here. This means you need to decide whether you wish to optimise the position for UK employees by securing a lower domestic EMI valuation agreement with HMRC, or whether you wish to maintain a parity of exercise price across your employee demographic.
In our experience, it is often better to award unapproved share options to US employees rather than attempting to introduce a tax favoured Incentive Stock Option (ISO). This is due to the complexity of complying with Internal Revenue Code 409A which imposes penalties on deferred compensation, compliance with state securities laws regarding shares not traded on a US national exchange, lack of tax deduction for the employing company, and the holding periods required to obtain capital gains tax treatment. In addition to these stipulations, the difference between the exercise price and the fair market value of the stock at exercise must be included by the ISO recipient as an adjustment in their alternative minimum taxable income for the year of exercise.
Whilst an ISO affords favourable tax treatment under s 422 of the Inland Revenue Code, it is conditional upon numerous restrictions affecting the plan's design. In practice, the holding period is usually the most limiting feature. To qualify for capital gains tax treatment, the ISO must be held for at least 2 years from the date of grant, and at least 1 year from the date of exercise. You will need to consider how this sits with your exit ambitions.
We have a number of clients with US incorporated subsidiaries and are happy to provide further details in relation to the tax and social security position for a US employee and the company in relation to the operation of a share option plan across the wider group. Overseas employees should also take their own local tax advice as in addition to federal charges there are local state income taxes payable which vary tax from state to state.
If you have any queries on this article please contact Liz Hunter on 020 8949 5522 or via