osborneclarke.com A Guide to Equity Plans For international companies with UK operations

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1 A Guide to Equity Plans For international companies with UK operations

2 Introduction This paper is designed to provide an insight into the main types of share plans available in the UK and practical guidance for international companies wishing to extend their existing plans to UK-based employees. The employee benefits world continues to be a fast moving one, providing challenges for multi-national businesses with employees operating across different jurisdictions. The effects of the global drive towards clear and consistent accounting policies for equity schemes have been notable, with the requirement to expense the costs of equity programmes continuing to influence the design of new and existing plans and, in some quarters, curtailing the desire of many entities to make equity widely available to staff. The regulatory framework ensuring equity participation is managed with the highest standards of corporate governance continues to evolve across the developed world. The UK has also experienced its own change in recent times, with the overhaul of the UK company law regime in 2006 and the introduction of the European Prospectus Directive, both having had a strong impact on how companies operate their equity programmes. The tax authorities in the UK have made public their stated aim of taxing as income all of the rewards of employment, whether provided in the form of benefits, equity or salary. The scale and complexity of anti-avoidance legislation introduced over the past few years to tackle this, has been unparalleled in our history. Since April 2010, the highest rate of income tax of 50% applies for anyone earning in excess of 150,000, making equity an even more attractive benefit from a tax perspective. New legislation is proposed for 2011 that will make it more difficult to defer the receipt of cash or shares without triggering immediate income tax charges. Yet the UK retains certain benign regimes when it comes to employee share ownership. If structured correctly, equity plans can not only deliver retention and incentivisation but also tax efficiency for participants and sponsoring companies. Many internationally-based companies have major operations in the UK, but few consistently extend their share incentive plans to include UK employees, due to misconceptions over the associated cost and complexity. Osborne Clarke's incentives team is ranked among the best of the UK and has many years' experience of achieving employee participation in a straightforward and tax-efficient way. We specialise in advising international companies that operate in the UK on how to avoid the pitfalls and achieve the best tax savings, whether launching new or existing plans. We also play an active role in our international clients' merger and acquisition activity across Europe and advise on the impact such corporate activity can have on equity based incentives. "This broad-based practice represents both public and private companies, providing them with responsive service and work that is not only done well, but also in a cost-efficient manner. They simply do great work." Chambers UK, of 8 Osborne Clarke May 2010

3 UK plans UK plans Many of the tax breaks associated with equity programmes in the UK have been aimed at high growth entrepreneurial businesses. These types of companies (including those incorporated outside the UK but with a trading subsidiary in the UK) have benefited from the highly favourable enterprise management incentive (EMI) regime. Unlike many of the UK tax approved regimes, EMI is a discretionary scheme which can be made available to selected employees. In certain sectors, e.g. technology, EMI options are an extremely common element of the remuneration package at all levels and, with early-stage entities, are often used in connection with salary sacrifice arrangements. Whilst the EMI legislation is very flexible in terms of scheme design, companies must fit within the rules and, in particular, must have less than 250 employees and gross assets of less than 30 million. Where EMI is not possible, the HMRC Approved Company Share Option Scheme is an alternative. Whilst capital treatment can be achieved, the cap on benefits for participants is much lower than with EMI and the regime is more restrictive. Other tax approved plans in the UK must be offered to all qualifying employees as described in further detail later in the paper. 3 of 8 Osborne Clarke May 2010

4 UK plans UK discretionary option plans The table below provides a summary of the key features of the different types of UK discretionary option plans which can be offered to selected employees and their tax treatment: Type Qualifying conditions Limits Exercise price Exercise period Tax treatment Approved Company Share Option Plan (CSOP) Requires prior approval of HMRC Conditions as to type of shares, company and employment status of participants 30,000 of shares under option for each participant (Note i) Must be set at the market value at grant (this requires agreement with HMRC in advance unless shares are listed) Usually between 3 and 10 years from grant Can exercise earlier but may not obtain tax benefits Exercise can be subject to performance No income tax or social security if exercised between 3 and 10 years from grant Capital gains tax on sale Special treatment for 'good' leavers Enterprise Management Incentives (EMI) No prior approval from HMRC (Note ii) Conditions as to independent status of company granting option, trading activities, number of employees and level of gross assets of group 120,000 of shares under option for each participant 3 million of shares under option in total Can be any price Should be agreed with HMRC in advance to ensure tax breaks are achieved Exercise at any time up to 10 years from grant Options can have vesting schedule or be triggered only on a sale or flotation No income tax or social security on exercise unless exercise price is less than market value at grant Capital gains tax on sale Unapproved None None Can be any price Exercise at any time up to 10 years from grant Income tax and social security charges on exercise, withheld and accounted for by employer (Note iii) Further tax elections may be needed (Note iv) Notes i. The 30,000 limit for approved CSOP options is relatively low. However they remain popular in the UK as capital gains tax, which is charged at either 28% or 18% (irrespective of how long assets are held), is generally more favourable than income tax. ii. EMI options may be granted under an individual agreement or a set of scheme rules and there is no prior HMRC approval process. The company and the participant must 'self-assess' (with input from their lawyers) whether they qualify and the grant of options must be notified to HMRC shortly after the options have been granted. It is usually a simple process to amend a non-uk share option agreement to enable it to qualify as an EMI option in the UK. iii. Social security charges (employers' and employees' national insurance contributions (NIC)) must be withheld and accounted for to HMRC by the employer. UK rates of social tax are relatively high. The current rate of employer social tax is 12.8%, increasing to 13.8% in April 2011 and the liability is uncapped so, where option gains are large, this is a potentially significant liability for companies. It is possible for the employer to transfer the employers' NIC liability to the participant. If this is done under an HMRC approved form of election, there is no requirement for the issuing company to account for contributions over the vesting period. Employees will obtain income tax relief on the employer contributions met. iv. If UK employees have acquired shares which are subject to forfeiture or sale restrictions (generally speaking, those of a private company) they should normally enter into a further tax election to ensure future gains fall within the capital gains tax regime (and they are not subject to further income tax and NIC charges) on eventual sale of the shares. 4 of 8 Osborne Clarke May 2010

5 UK plans UK all-employee plans The following table compares two further HMRC-approved plans which must be offered to all employees: Plan Qualifying conditions Share awards Exercise/ purchase price Limits Exercise holding period Tax Saving- Related Share Option Plan (SAYE) Requires prior approval of HMRC Conditions as to type of shares, company and participants Must be offered to all employees who qualify Option, funded by monthly deductions from salary into an approved savings contract with bank or building society Can be at a discount of 20% to market value May need to be agreed with HMRC Monthly savings cannot exceed 250 Option period of 3, 5 or 7 years, after which time option can be exercised using savings Alternatively, participants can decide not to exercise and retain savings (plus taxfree bonus) No tax or social security if exercised after 3 years from grant Special rules for leavers Share Incentive Plan (SIP) Requires prior approval of HMRC Conditions as to type of shares, company and participants Must be offered to all employees who qualify UK trust required to hold plan shares Partnership shares (deductions from pre-tax salary) Free shares Matching shares Dividend shares (or any combination) Acquired at market value Annual individual limits 1,500 for partnership shares 3,000 for free shares Up to 2 matching shares for each partnership share Maximum benefits once shares have been held in the plan for 5 years Reduced benefits after 3 years No income tax or social security on any shares held for 5 years Income tax and social security if shares taken out and sold before 5 years Shares protected from capital gains tax whilst in the trust Corporation tax relief The UK system allows a UK employer a tax deduction in respect of all types of share awards and benefits, regardless of whether they are taxed as income in the hands of its employees, provided they fulfil certain requirements. As the deduction is equal to the market value of the shares at the date of award or, in the case of an option, the gain made at exercise, the potential tax relief can be extremely significant. Certain requirements must be met as follows: The shares or option (as relevant) must be acquired by reason of the participant's employment with the company claiming relief. The award must be made for the purposes of a business carried on by the employing company where that business is within the charge to UK corporation tax. The shares acquired under the relevant arrangement must be in: an independent company; or a company listed on a recognised Stock Exchange; or a subsidiary of a company whose shares are listed on a recognised Stock Exchange. The shares acquired must be in the employer company or its parent. A UK subsidiary of an overseas listed parent may, therefore, claim a deduction whether it offers benefits under a UK tax-approved plan or not. It is important to ensure that plan rules are drafted carefully to ensure that the relief remains available, particularly in the context of a takeover or sale of the company. 5 of 8 Osborne Clarke May 2010

6 Non-UK plans Issuing options to UK employees under a non-uk parent plan In normal circumstances, a non-uk option plan would be unlikely to qualify as an approved option plan in the UK without taking further action to seek approval in the UK. However, it is often possible either: to adopt a new qualifying plan specific to the UK employees, but bearing as many of the characteristics of the basic plan as possible (as well as other provisions to compensate UK employees for aspects which are less favourable than for their non-uk counterparts); or to make amendments to the existing plan to achieve tax approval. If neither of these routes is desired or possible, UK employees holding options granted under a non-uk plan will be unapproved for tax purposes. The treatment will be as set out in the table on page 4. Aside from tax considerations, there are a number of other legal issues international companies should consider when rolling out share plans in the UK. These include the following: Although the securities law regime in the UK is relatively relaxed, companies offering shares to UK employees should be satisfied that there is no requirement to issue a prospectus. Many equity arrangements offered will be outside the ambit of the European Prospectus Directive, but if they do fall within the requirements, it may be possible to fall within one of the appropriate exemptions. It is important to ensure that the non-uk parent corporation and the UK employing entity have adequate powers within the plan rules to enable tax withholding requirements to be discharged in a timely way. The trend in the UK for ever increasing protection for employee rights continues. International parent corporations should look to ensure that the employer has adequately protected itself from claims in relation to lost equity rights as a result of unfair or unlawful dismissal and that it is not laid open to claims of discrimination on the grounds of age, race or gender. Most equity plans operated in the UK whether tax approved or unapproved require the employer company to file annual returns within three months of the end of the tax year. The incentives team would be delighted to lead you through these issues and ensure compliance with UK laws. 6 of 8 Osborne Clarke May 2010

7 Our experience Recent examples of our work include: Motorola Advising Motorola Inc. on a number of UK acquisitions of businesses with extensive employee ownership Facebook Advising Facebook on extending its equity arrangements throughout Europe Nystar N.V. Advising Nyrstar NV on the legal and regulatory aspects of the global implementation of a senior executive and all-employee plan US Technology companies Advising several US-based technology clients on the implementation of EMI option plans for UK employees. We offered a full service, including reviewing the terms of the US stock option plans, drafting new agreements for the purpose of granting UK options, preparing submissions and valuations for HMRC and advising on transferring liability for UK employers' social security contributions 7 of 8 Osborne Clarke May 2010

8 Our people About Osborne Clarke We are known for our ability to turn legal expertise into commercial advantage for our clients by applying imaginative thinking to their issues and challenges. With over 700 staff and 112 partners, we have offices in the City of London, Bristol and Thames Valley, Cologne and Munich and Silicon Valley in California. Through our alliance with seven likeminded European law firms, we also have a presence in France, Belgium, Italy, Spain, the Netherlands and Luxembourg. Contact For further information on any of the issues raised in this guide, please contact: Karen Cooper Partner [email protected] Sue El-Hachmi Associate [email protected] Mairi Granville-George Associate [email protected] Sian Story Solicitor [email protected] These materials are provided for general purposes only. Osborne Clarke does not accept liability for the contents of these materials and legal advice should be taken in respect of a particular matter. 8 of 8 Osborne Clarke May 2010