Protecting you tax-advantaged share schemes
06 June 2019
The use of tax-advantaged share schemes continues to grow inthe UK as these schemes, if operated effectively, could potentially result insignificant tax reliefs for employees. In order to qualify for the reliefs, itis imperative that the employer company continuously satisfies HMRC’s on-goingcompliance requirements whilst the schemes are in operation.
The compliance requirements can be quite detailed andcompanies sometimes fail to keep up with their obligations. This means thatwhen employees seek to benefit from their participation in the schemes, often onan exit event such as a sale or IPO, due diligence reveals that the tax reliefsmay no longer be available to the employees.
We set out some of the key on-going compliance requirementsfor share schemes that companies must satisfy once they have made awards totheir employees.
Registering andnotification of options
The employer company is required to register the EMI schemeand notify HMRC of all options granted within 92 days from the date the optionsare granted. This should be done using HMRC’s onlineservices.
It is a statutory requirement that all employees declarethat they satisfy the EMI legislation’s minimum working time requirement at thetime options are granted (the working time declaration). This declaration maybe drafted into the Option Agreement (provided it is signed by the employee) or may be a separate document that must besigned and submitted to the company by the employee. It is important to notethat an employee must submit a working time declaration every time he orshe is granted options by the employer company.
Failure to submit a working time declaration at the time ofgrant could lead to the options failing to qualify for EMI tax treatment withincome tax and national insurance contributions arising at the point ofexercise.
Restrictions on Shares
For options to qualify for EMI tax treatment, there is arequirement to notify employees of restrictions attaching to shares over whichthey have been granted options. HMRC’s view is that referring to the articlesof the company in the option documentation may not suffice: the restrictions shouldbe clearly set out and brought to the employees’ attention.
Failing to notify employees of the restrictions attaching totheir option shares may lead to the options losing their EMI tax treatment. Ifthe share rights have been updated since the last round of grants, it isimportant that the company’s EMI scheme documentation is amended to reflectchanges to restrictions on the shares.
Whilst it is not a requirement to agree with HMRC on thevalue of the shares to be used for an EMI, we advise that companies should seekagreement. This should ensure thatthere is no question as to the exercise value of shares used for an EMI when itcomes time for exercise provided that full information was provided to HMRC.Why is this important? Shares obtained through an EMI scheme will be subject tocapital gains tax on the difference between the market value at the time ofgrant and the market value of the shares on the date of exercise. If the marketvalue of the share at the time of grant was less than the market value on thedate of exercise, income tax is charged on this difference. The remaining gainis then subject to capital gains tax.
In most cases, companies granting EMI options are still inthe growth phase and are working towards increasing the company’s value for apotential exit. Therefore, at the time employees come to exercise theiroptions, the company’s share value may have significantly increased and if themarket value at the date of grant has not been defined, the amount subject toincome tax (i.e. the difference in share values at the date of grant and thedate of exercise) is at least open to question.
Online annual returns
You must complete an employment related securities onlineannual return for all the tax-advantaged share schemes run by yourcompany. To do this, you would have to register the scheme by 6 July followingthe end of the tax year within which the scheme was set up (excluding EMI wherethere is a 92-day deadline). After completing the first return, you must submitan online return by 6 July each year for every year that the scheme remainsactive, even if there is no reportable event in that year (in which case youwill have to file a nil return).
Failure to properly file your annual returns may incurpenalties from HMRC. HMRC will not send you a reminder to file your online annualreturns.
Companies should identify who is responsible for monitoringall share schemes currently in operation and keeping track of the number ofoptions or shares held by employees. This includes keeping track of employeeswho leave, share options that lapse, etc. These internal records will be usefulwhen completing the annual online annual returns and for the purpose ofassisting with a due diligence search in the event of a subsequent sale or IPO.
Pett, Franklin & Co. LLP are experts in employee share schemes, executive incentives and share valuations. To find out more about how we can help you or your client, please contact Stephen Woodhouse at email@example.com or call 0121 348 7878.