15. Employee Share Schemes (5%) (P4)

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Employee share scheme

CA06 s.1166

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'A scheme for encouraging or facilitating the holding of shares or debentures in the co by or for the benefit of bona fide employees or former employees, or spouses/civil partners/ surviving spouses/(step)children under 18.

- All-employee v discretionary - (discretionary - usually defined by seniority/function/duration of service).
- 'Bad' v voluntary leaver - stop/limit benefit if resign voluntarily or dismissed for misconduct. Good/involuntary - ill health/redundancy - some benefits available.
- Dilution
- Exercise - process by which participant takes up his right under certain schemes to convert option into a share
- Exercise period - window of opp to exercise their option or claim their incentive.
- Exercise price or option price - usually set at time of grant re prevailing market price or by using a formula.
- Grant - process by which co awards participant an option, share or other incentive.
- 'In the money' option - when market value of a share at point of exercise is greater than ex price. Opposite is 'underwater'.
- HMRC-approved scheme - scheme designed and administered according to HMRC req's.
- Lapse - most options/incentives have a finite period
- Maturity/Vest - min waiting period before option/share/incentive is available to participant, in whole or in part. When available - vested.
- Option - right granted by co giving P opp to acquire shares at a price or a formula fixed at outset. Converting option into share called 'exercising an option' m
- Performance condition - conditions to be net to exercise/receive option/incentive.
- Scaleback - more than max no. of options/shares available to e/es applied for - reduce them.
- Scheme rules or plan rules - governance rules
- Vesting period - min period until option/share/incentive available to P, in whole or in part.

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Share incentive plans (SIPs)

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- must be offered to all full-time + part-time UK resident e/es (unless material interest in co)
- min service reqs may be set but not more than 18 months
- HMRC-approved schemes - must follow rules, but flexible concept
- if vol leave w/in 3yrs of award - co discretion re forfeit, sp exemptions if invol
- free shares up to annual limit of £30k - no tax or NIC liability - distribution must be based on targets + not focused on highly paid inds.
- partnership shares bought by e/e up to £1.5k or 10% annually - min can be set but not more than £120pa. Purchased pre-tax + pre-NIC earnings (deductible from e/es tax calcs so reduces e/es taxable income).
- e/r can give matching shares to match partnership shares - not to exceed 2:1 + lower of max £3kpa or 20% of e/es annual salary.
- combi of the 3 poss
- tax-efficient way of accumulating shares
- div payments up to £1.5kpa can be reinvested
- all shares held in trust on behalf of e/es - must be fully paid + irredeemable.
- free + matching shares must be held in plan for at least 3yrs + for max 5yrs
- partnership shares can be taken out immediately
- when e/es leave, all shares come out of the plan.

Tax implications:
- no income tax or NIC on value of free, matching or partnership shares if kept in SIP for 5+ yrs
- income tax + NIC payable on market value if shares taken out before 3 yrs after grant
- income tax + NIC payable on free + matching shares if taken out of plan between 3-5 yrs after grant, based on lower of value when awarded or when taken out
- no income tax on div shares reinvested provided held for 3+ yrs
- no CGT payable on any increase in value
- no CGT payable if shares withdrawn after 3 yrs + immediately sold (if not immediate, CGT payable on diff between current value + value when shares withdrawn)
- no income tax or NIC payable if leave involuntarily
- corporation tax relief for costs of setting up/running plan + further relief for acquiring share on behalf of e/es and for value of gross salary of partnership shares purchased by e/es

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Savings-related schemes (sharesave schemes) or Save As You Earn (SAYE)

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- e/es have opp to buy shares in their co at discounted price
- e/es can save up to £250/month via a savings contract to buy shares (for 3, 5 or 7 yrs)
- savings kept at bank or building society until savings contract matures
- tax exemptions available when e/es exercise their options
- HMRC-approved schemes - qualifying service must be for less than 5 yrs + e/e can't own/control 25%+ of the shares
- all-employee - full-time or part-time on equal terms
- option price set by ref to market value of shares at time of grant but e/r has discretion to discount up to 20%
- e/e enters into contract to save with a 'savings carrier' for period of 3 or 5 yrs + e/e can save between £5-250/month. E/e then receives tax-free bonus which is added to accumulated savings. If 5yr option taken, option to take proceeds after 5th yr + exercise their option to buy, or leave savings for another 2 yrs (no further contributions + earn additional tax-free bonus)
- 6 months to ex options at end of savings period or lapse
- if left involuntarily - can use savings until they leave to purchase shares at option price + usually have 6 months to exercise this
- if death a pers rep has up to 12 months to ex options from date of death
- don't have to ex option - if underwater can simply take savings

Tax implications:
- no income tax or NIC payable on bonus or interest received under savings contract, or on benefit from buying shares at favourable price, or on any increase in value of shares between grant/exercise
- same applies if ex option prior to end of savings period due to invol leaving co
- subj to income tax if allowed to ex after leaving voluntarily
- usual rules of CGT when shares sold

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Comparison between Sharesave and SIP

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- savings under the SIP are prior to tax and NIC so more tax-efficient for e/r + e/e
- more flexibility in design of SIPs than sharesave schemes

- sharesave schemes offer lower risk to e/es (if options become underwater can continue saving through SAYE contract, receive tax-free bonus at maturity + allow sharesave option to lapse). As SIP involves purchases of shares, poss of adverse movements in price increases risk profile.
- sharesave schemes are simpler to understand than the SIP

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Profit-sharing schemes

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HMRC-approval status withdrawn in favour of SIPs so no tax reliefs available.

- Purpose is to give all e/es a common target + share in proportion of profits which is used to subscribe for the employing cos shares or to purchase the shares in the market.
- Shares held in trust for a qualifying period (usually 2 or 3 yrs) before released to e/e.
- No perf conditions usually apply in qualifying period as perf met at outset.
- Consider if P should have beneficial interest during qualifying period (e.g. vote/divs etc - tax implications).

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Company share option plans (CSOPs) or executive share option plans (ESOPs)

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- e/es can receive up to £30k worth of tax-approved options
- the options can be exercised between 3 and 10 yrs after grant
- operated on discretionary basis (senior managers usually) - grants option to purchase shares at future point. Expect price to rise so that when exercised P will purchase at lower price than prevailing price. The excess is a 'gain'.

To be HMRC-approved:
- ltd to e-es (can't own/control 25%+ of a close co or had such an interest in past yr)
- options granted at no less than fair market value of underlying shares
- options must no be transferable or pledged as a security
- shares must be fully paid + usually ord shares (no special rights/restrictions)
- if co has 2+ classes, class offered must not be controlled by d's or e/es or by hold co
- options may be exercisable for between 3-10 yrs (sp circs if invol termination, change of control of co, or death)
- limit of £30k on aggregated market value of options granted per P (determine at time of grant). If more - part of unapproved pain under which income tax payable upon exercise of option.

Tax implications:
- no income tax chargeable when option granted
- no income tax or CGT on increase in value of shares between grant/exercise
- no income tax on disposal of shares
- CGT may arise when shares are sold
- e/r - cost of running CSOP deductible against cos profits for determination of cos tax liabilities
- unapproved CSOPs - income tax lability may arise at time of grant where option price less than fair market value of underlying shares.

Exercise process - to provide exercise price may immediately sell some shares then met by a short-term loan or by undertaking to the co to pay the exercise price. Or provide cost themselves (cheque/bank transfer).

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Enterprise management incentives (EMIs)

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- suited to smaller (gross assets less than £30m), high-risk cos wishing to operate tax-efficient scheme - retain high-calibre e/es + reward them for taking risk (must be less than 259 e/es + must work 25+ hrs/wk).
- e/es can receive up to £250k worth of options (inc any amount granted under CSOP)
- co may have up to £3m shares in value under EMI option, any no. of qualifying e/es can participate
- options can be exercised between 3-10 yrs after grant
- fewer formalities than a CSOP
- HMRC-approved but no approval/clearance mechanism (can get pre-approval if unsure). Notify HMRC w/in 92 days of grant of an EMI option (notification, dec from e/e re hrs/wk, dec from sec or d re reqs met, copy of option a/g).
- shares must be fully paid up and not redeemable
- can be subject to perf conditions at discretion of e/r or can be all-employee
- no e/e or d can have more than 30% interest in sh cap of co to participate

Tax implications:
- no income tax or NIC when options exercise if ex price is the market price at date option granted
- income tax charge if options are granted at less than market value, based on value of the discount
- CGT on shares sold following exercise of options

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Long-term incentive plans (LTIPs)

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- discretionary basis but could operate on all-employee basis
- usually provided by listed cos
- no HMRC-approved structure so necy to structure in a way that takes into account way of minimising tax
- shares allocated into a trust (usually offshore) to 'warehouse' the shares + release when appropriate
- award is conditional/deferred over perf period – usually 2-3 yrs
- potential further waiting period of 2 or 3 yrs prior to release – beneficially entitles but remain in trust
- concessionary features allow P to receive at least pro-rated award of shares if invol left

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Comparison between LTIPs and option plans

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- usual LTIP arrangement is to make conditional/deferred award of shares whereas option scheme doesn’t award shares just a contractual right to acquire shares
- allocation under LTIP is into a trust which means e/r must fund cash at time of award (working on assumption that shares will increase in value over time so cheaper to acquire now = ‘hedging’ strategy) – t/f CF position to be considered

- value to P of option is diff over which market price of share exceeds option price + if option is underwater unlikely to have any meaningful value, while under an LTIP P is entitled to whole share + receives some benefit no matter the market price

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Introducing and administering an employee share scheme – considerations

(medium- to long-term benefits)

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How to implement? How it fits with other incentives? Combi? Target? All-employee or discretionary?

- HMRC-approved scheme? – tax reliefs v potential additional flexibility of not necy HMRC-approved scheme
- Finances of co? – impact of operating the scheme? E.g. immediate cash input for some schemes.
- Dilution impact on issued sh cap? – new issues exempted from provision re pre-emption rights – req s/h approval (ord res). Outweighs positive motivational effect?
- General cost & admin burden? – complex, large no. of Ps, costs
- Potential for discrimination? – Ps must be selected fairly in any discretionary scheme

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Scheme rules

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Usually drafted by co’s legal advisers or in HMRC-approved schemes may follow model. Include:

- name – each e/e should have unique name
- duration – date scheme approved by s/hs + HMRC if applicable, and date scheme expires
- auth to make grants – provision that board/committee has auth
- no. of options/shares available – max no.
- definition who is eligible – description
- form of documentation – provision empowering d’s to decide/modify specific form to be issued so that rules not amended each time doc changes
- description of option price, shares, incentive or other benefits – exhaustive or more generic w/ auth for d/s to determine certain specific issues
- concessionary features for invol leavers
- potential loss of benefits for vol leavers – restrictions
- exercise period and procedure – period and manner
- power to modify scheme rules – provision allowing d’s to make minor modifications to rules
- variations of sh cap – power for d’s to adjust value +/or no. of options/shares/incentives granted in event of a capital trans such as a rights issue, subdivision or consolidation
- takeover or change of control of the co – provisions which allow some/all of option/share/incentive to be rec’d early or exhcnage for benefits in acquiring co
- treatment of incentive in case of WU, insolvency, scheme of arrangement – risk of forfeiture of the incentive

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Role of HMRC (for HMRC-approved schemes)

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- set qualifying conditions (so keep up-to-date)
- annual tax returns submitted for each e/e share scheme – incs info on options exercises or shares granted or transferred + enable HMRC to determine whether been managed in acc w/ req’s. Also provide to determine tax liabilities or reliefs
- all modifications to scheme submitted to HMRC for approval otherwise jeopardise approved status
- sec should maintain file of modifications, BM/GM copies, HMRC letters

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Establishing an employee share scheme

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- consider most appropriate type
- draft req’d documentations (rules, certs, booklets, presentations, maturity documentation, support materials)
- check Arts – nothing preventing scheme – amendments by sp res
- consult HMRC if applicable
- consult major inst. s/hs if applicable

- obtain board approval
- obtain s/h approval (ord res) – disclose full text of scheme if listed in a circular
- obtain HMRC approval, if applicable – submit scheme rules + timescale/procedure
- prep + issue documentation + begin e/e briefings – option/grant certs must be issued w/ explanatory booklets

May use treasury share a/c in satisfaction of e/e shares schemes.

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Role of company secretary

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- establish + maintain a register of participants – nb if d’s of listed co participate – RIS
- establish + maintain a central file of documentation – rules, HMRC letters, pro-forma option or grant certs
- issue grant documentation (+monitor level of interest)
- monitor achievement of perf conditions, vesting and lapses – e.g. shares to be transferred
- deal w/ queries (+ admin matters e.g. P’s change of add, someone leaving etc)
- complete annual tax returns – HMRC has pro-forma tax returns which need to be completed/returned
- manage ad hoc events e.g. scalebacks and variations in sh cap
- prep and issue maturity packs – brief e/es on choices + timescales
- issue ad hoc documentation – perhaps regular reports (annual?)

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Additional issues for listed companies

CGC & LRs

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Institutional s/h guidelines (ABI & NAPF):

- link rem to perf + limit proportion of shares available for e/e acquisition (max 10% of issued sh cap in any 10-yr period), limit in participation + clear evaluation + disclosure of cost
- grants of options should be phased (awards on a sliding scale) re stretching perf criteria
- costs of running scheme transparent
- participation should be restricted to bona fide e/es + exec d’s, w/ appropriate limits which are disclosed. Not to NEDs
- proved for grant of options in a ‘window’ following RNS of half-yr or annual published results – so options granted w/in 42 days following date of any RNS of results + no grant made later than 10 yrs after establishment of scheme.

Also consider Model Code – ‘Dealing’ – includes grant or exercise of options under option schemes (exception for all-e/e schemes) + transfer/disposal of shares/rights under these schemes. Under DTRs must announce changes in d’s interests.

Consider docs to be submitted to UKLA for any new shares issued – some exemptions under block listing regime (no prospectus).

D’s Rem Report Regs 2002 – req’s extensive disclosure of d’s rem inc participation in e/e share schemes. Made in ARA.