Equity compensation for NEDs
Non-executive directors (NEDs) often get the short end of the stick when it comes to equity rewards. Although they are not normally employees, any share-based gains they receive for their services are deemed employment-related securities for tax purposes. These are normally subject to income tax unless the rights are awarded under one of the tax-advantaged, government approved employee share schemes. These include the Enterprise Management Incentive (EMI) (for smaller companies) and the approved Company Share Option Plan (CSOP). But because NEDs are normally not employees, they cannot benefit from these schemes.
What to do? One solution is the Deferred Share Purchase Plan (DSPP). The participant contracts to purchase shares at full market value but pays only a small initial deposit. Later, when the shares have hopefully increased in value, they can be sold on (perhaps in a trade sale or flotation) and the participant can receive the profit, being the proceeds less the initial market value. This is not a government backed scheme and can therefore be designed flexibly. Performance and loyalty conditions can be built in, much like an option scheme.
But there's a downside. The participant has contracted to pay the full market value, and therefore if the company goes into liquidation the receiver could pursue the participant for the unpaid balance. This can be mitigated if an Employee Benefit Trust (EBT) is used to acquire the shares and then sell them on to the participant. But an EBT may not be suitable if the NED has no relationship of employment, and in any case any unpaid balance on shares due to the EBT would be subject to tax as a benefit in kind.
Other solutions exist. One, known as a Joint Share Ownership Plan (JSOP), divides the ownership of the shares between an employee trust and the participant in such a way that the trust continues to hold the present value of the share while the participant is entitled to any increase in value over time. Sometimes this entitlement is subject to a hurdle rate of, say, 5% per year. This reduces the value of the participant's entitlement. This still has a value, however, and if the participant does not pay for it when received, there will a tax charge on the value. Again, there are ways to mitigate this problem but they add a further layer of complexity.
Another approach is to avoid appointing the NED as a director at all, and retain him or her as a consultant. On this basis it may be possible to grant unapproved options subject to capital gains tax only. However, once again there are traps for the unwary. HM Revenue & Customs can in theory seek to tax the intrinsic value of the share option at grant. Employee share options cannot be taxed at grant but non-employee options can. Another possibility, bizarrely, is the HMRC could seek to impose VAT on the value of the options, on the grounds that they have been awarded in exchange for VAT-able services.
It should also be noted that HMRC has indicated that it is reviewing what it describes "geared growth schemes" to see if they should be more heavily taxed. JSOPs arguably fall within this definition. Although these schemes are in no way abusive, it is possible that HMRC may impose some kind of penalty tax treatment, and in these cases they also have powers of retrospection.
The best answer to the NED problem will depend on the particular facts of the case, and the above notes are a very brief summary only.
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