Equity incentives: Top Tax Tips (part 1)
For many companies, share option schemes are now a core element of remuneration strategy. Their principal uses are to help encourage loyalty and focus attention on building performance and shareholder value. But, if the schemes are well designed, they can also offer substantial tax benefits to employee, company and business owner alike.
This month we offer our top tips for maximising Corporation Tax Relief for the employer and Entrepreneurs' Relief for the employee. Next month we cover the taxation of employee trusts, how to maximise the tax savings for owner directors, and the importance of tax compliance.
Getting the most from corporation tax relief
Not all companies are aware that when share benefits pass to employees for example, on exercise of an option corporation tax relief is often available on the amount of benefit, as if the benefit was cash payment. This is potentially very valuable.
Nevertheless, the Corporation Tax Relief is easily lost. This usually occurs on the sale of a private company to another private company. If the options are not exercised until after the main shareholders have sold, the shares acquired through exercise will no longer qualify for Capital Gains Tax (CGT) treatment relief. The problem does not arise if the acquiror is listed.
To get around this issue, make sure that the options can be exercised prior to sale. The wording has to be carefully drafted, however, since if the exercise is conditional on the sale going ahead, HM Revenue & Customs may argue that there was never a real exercise and withhold the tax relief anyway.
Maximise Entrepreneurs Relief
Entrepreneurs' Relief (ER) is a special tax rate of 10% that applies to Capital Gains on shares where the individual is an employee or director of a company and has held 5% or more of the share capital, carrying 5% of the votes, for at least a year.
Share options don't qualify for ER. So if options are exercised on a company sale, and the shares immediately sold, capital gains tax will be payable at 18%, or more likely, 28%.
You can circumvent this problem by allowing the individual to exercise early. You could lend him the money to do so, and providing he acquires the necessary shares he will qualify for ER. However, he may pay tax on the benefit of the loan and the company (if close) could also pay a temporary tax rate of 25%, repayable when the loan is repaid. The latter tax may be avoidable with careful planning, but professional advice is essential.
A more aggressive solution to this problem is to issue the person with special shares carrying 5% of the votes but negligible dividend or capital rights. He or she may pay a small amount of tax on the very limited value of the shares received. However, if the new shares are held for at least a year this will ensure that (under current rules) any subsequent sales of shares qualify for ER, even if only held for a short period.
Please note that it is possible that HM Revenue & Customs will regard this method as a loophole and seek to close it. That said, they have shown no signs so far of any intention to do so.
If you would like to discuss anything in this article please call RM2 on 020 8949 5522 and ask to speak to any one of our advisers.