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Equity-based incentives

Share options What are the most common types of share option plan in your jurisdiction? Please outline the rules relating to each scheme.

There is a significant degree of flexibility in the design of share option plans in the United Kingdom. Plans where the exercise price is the market value at the time of grant or nil (or the par value of the shares in some cases) are both common. There is freedom to structure vesting conditions and exercise periods in accordance with commercial requirements, although there are more restrictions on the tax-advantaged arrangements.

Tax-advantaged option schemes are as follows:

  • Company Share Option Plan (CSOP) ‒ this is a discretionary option plan, in that the company can choose who participates. Options must have an exercise price of at least the market value at the date of grant, and the value of shares under option to any one person (valued at the date of grant) cannot exceed £30,000. Generally, options must be exercised after the third anniversary of the date of grant for the tax benefits to be obtained. There are various conditions to be complied with for a CSOP, and the company must self-certify to the tax authority that the plan meets the relevant conditions. The company whose shares are used cannot be under the control of another company. Multinationals based outside the United Kingdom often adopt a CSOP sub-plan for UK employees.
  • Save As You Earn (SAYE) ‒ this option plan is an all-employee plan and must be offered to all UK tax-resident employees of participating companies, with certain exceptions. The plan involves the grant of options alongside a savings arrangement, under which deductions from salary are paid into the savings plan each month, and on maturity of the option the savings are used to exercise the option. Three and five-year options may be granted, with three-year options being the most popular. The exercise price cannot be less than 80% of the market value of the shares at the date of grant, and the deductions from salary are limited to £500 a month. There is little flexibility regarding the terms of these plans and the company must self-certify to the tax authority that the plan meets the relevant conditions. US companies sometimes use SAYE option plans to replicate the economics of an employee stock purchase plan.
  • Enterprise management incentive (EMI) options ‒ while attractive, these options are aimed at smaller growth companies and there are restrictions on the types of company that can offer EMI options, including:
    • gross assets for the group must be less than £30 million;
    • the total number of group employees must be less than 250;
    • certain trades are not permitted (eg, banking, farming, property development and provision of legal services); and
    • the company cannot be under the control of another company, with no arrangements in place such that a company may obtain control.

Individual participation is capped at £250,000 market value of shares at the date of grant per person.

What are the tax considerations for share option plans?

There is no tax charge on the grant of a share option to an employee.

If the option is not tax advantaged, the gain realised by the employee is subject to income tax, and if the shares are tradeable at the time of exercise or certain other conditions apply, this tax must be accounted for by the employer, and national insurance contributions (NICs) will also be due. With the agreement of the option holder, employer NICs can be recovered from the option holder.

For the tax-advantaged arrangements, assuming the options are exercised in accordance with the relevant requirements, there is no income tax due on exercise (save that, in the case of EMI options, if the exercise price is less than the market value of the shares at the date of grant, that discount is subject to tax on exercise). The employees may be subject to capital gains tax (usually at lower rates than income tax) on the sale of the shares, and the first £11,300 (tax year 2017/18) of gains is tax free. Holders of EMI options may be able to benefit from entrepreneurs' relief, which reduces the capital gains tax rate from 20% to 10%.

Generally speaking, the employing company gets a deduction from its profits subject to corporation tax equal to the gain realised by the employee on exercise. This applies regardless of whether the employee pays income tax on exercise.

Share acquisition and purchase plans What are the most common types of share acquisition and purchase plan in your jurisdiction? Please outline the rules relating to each scheme.

A share incentive plan (SIP) provides a flexible and tax-efficient way to offer shares to employees. Participation must be offered to all UK tax-resident employees of participating companies, subject to certain exceptions. There are four types of award:

  • Free shares – the employer may award up to £3,600 of shares free of charge to each employee.
  • Partnership shares – bought by way of deduction from pre-tax salary, with a limit of £1,800 a year (or 10% of salary if lower).
  • Matching shares – partnership shares can be matched by the company at a ratio of up to two free matching shares per partnership share.
  • Dividend shares – dividends paid in relation to shares held in the SIP may be reinvested into dividend shares.

Shares must be held in a specially established trust for five years for the employee to obtain full tax benefits.

A combination of partnership shares and matching shares is often used by US companies to replicate employee stock purchase plans for UK employees, but with better tax breaks (as the shares can be purchased from pre-tax income). However, the amounts that can be invested are lower.

What are the tax considerations for share acquisition and purchase plans?

Assuming that shares are held in a SIP for the full five years, no tax needs to be paid in relation to the acquisition of the shares, and there is no capital gains tax to be paid on any rise in value of the shares when held in the SIP. If shares are withdrawn early (eg, if the employee leaves the company), tax may be paid, but there are certain good leaver circumstances which remain tax free.

Phantom (ie, cash-settled) share plans What are the most common types of phantom share plan used in your jurisdiction? Please outline the rules relating to each scheme.

Both phantom share options (where the employee participates in the rise in value of the share) and phantom shares (where the employee participates in the whole value of the share) are common where the company does not want to use real shares. There is considerable freedom to structure these arrangements in accordance with commercial requirements.

What are the tax considerations for phantom share plans?

Tax and NICs are deducted from the cash amount at the time of payment in the same way as for the payment of a cash bonus.

Special rules apply in relation to payments to directors, where amounts can be taxed before they have been paid in certain circumstances, particularly where the deferred amount is no longer subject to forfeiture.

Consultation Are companies required to consult with employee unions or representative bodies before launching an employee share plan?

No.

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