The Finance Bill 2017 has introduced a long called-for change to the taxation of employee share options. The Bill provides that from 1 January 2018, SMEs in Ireland will be able to grant KEEP (Key Employee Engagement Programme) or "qualifying" share options.
Better Tax Treatment
An employee may exercise a qualifying option without incurring the liability to income tax, employee PRSI and the USC (typically totalling 52%) that he would have under the current rules. The employee will pay only capital gains tax (33%) on his profit when he sells his shares.
A number of conditions must be satisfied at the outset for an option to be granted as a qualifying option and many of those conditions must continue to be satisfied through to the date the option is exercised, which may be several years later.
The need to monitor compliance with quite complex conditions will present real challenges for SMEs. More significantly, the relatively low financial limits (aggregate €3,000,000 market value of options per SME) will make KEEP options unattractive to start-up companies who are ambitious for a successful exit.
The Finance Bill 2017 will pass through several stages of the Houses of the Oireachtas before it is enacted in or around December 2017. There is a brief opportunity to amend the draft KEEP provisions to create a new system of taxation that SMEs would more readily embrace.
For now, we have set out below an outline of the KEEP provisions as currently proposed, and we have highlighted some difficulties they may present.
Conditions for proposed KEEP/Qualifying Share Options
The company must:
- be an SME (have no more than 250 employees (globally) and an annual turnover not exceeding €50 million, and/or an annual balance sheet total not exceeding €43 million);
- be incorporated and resident in Ireland, or resident in another EEA state and carrying on business here;
- not have shares or other securities listed on a stock exchange (excluding the Enterprise Securities Market of the Irish Stock Exchange); and
- be engaged in a trading activity. (Some activities are excluded, including professional services, dealing in securities, land development, construction and forestry).
The individual to whom a KEEP share option is granted must:
- be a full-time employee or director of the qualifying company and required to devote at least 30 hours per week to it; and
- not directly or indirectly control more than 15% of the ordinary share capital of the company.
The share option must be over ordinary shares and have an exercise (or "strike") price that is not less than the market value of the underlying shares on the date the option is granted.
There is no guidance as to how an SME can determine the market value of its shares on a basis that the Revenue Commissioners will certainly accept.
Limit per Employee
The total market value of all shares subject to qualifying options granted to an individual may not exceed:
- €100,000 in any tax year;
- €250,000 in any three consecutive tax years; or
- 50% of the individual's annual pay in the tax year in which the option is granted.
Imposing a limit based on each employee/director's pay will be burdensome to administer, and the draft legislation is unclear as to when the market value is measured.
The total market value of all unexercised qualifying options may not exceed €3,000,000. This applies over the entire period from the date of grant of an option to the date on which it is ultimately exercised. It is unclear how the market value must be calculated.
A qualifying option generally may not be exercised:
- earlier than 12 months after it is granted;
- later than 10 years after it is granted; or
- later than 90 days after the option holder ceases to be an employee or director.