Which type of plan is most tax effective for UK participants in a US employee stock plan?
There are four types of share incentive plan which confer favorable tax treatment on UK resident participants:
- Approved CSOP. This is a share option plan approved by HM Revenue & Customs (HMRC) under which options may be granted to selected employees or directors to acquire shares at a price equal to the market value of the shares at the date of grant. There is a limit of £30,000 on the value of shares which may be held by any one employee at any one time under outstanding options. No income tax or social security contributions arise on the grant or (generally) exercise of Approved CSOP options. Capital gains tax (CGT) is payable on the subsequent sale of the shares, subject to the individual's annual CGT allowance (currently £10,600). CGT is payable at 18 percent or 28 percent for higher and additional rate taxpayers.
- Enterprise management incentive (EMI) options. EMI options, geared towards small and mid-sized companies (companies/groups with fewer than 250 employees and assets not exceeding £30 million) may also be offered on a selective basis to employees or directors. There is no minimum exercise price, though there is a limit of £120,000 on the value of shares over which EMI options may be held (measured at grant date) by any one employee, and an overall company limit of £3 million. There is also generally no income tax or social security charge on exercise of an EMI option subject to the option exercise price not being at a discount to market value at grant. If the option is granted at a discount, such discount is subject to income tax (and sometimes social security charges) upon exercise. CGT is payable on sale of the shares.
- SAYE (sometimes called Sharesave) plan. A sharesave plan is also an option plan under which employees acquire shares upon exercise with funds which have been saved over the life of the option in a separate tax-free savings account. Options may be granted at a discount of up to 20 percent of the market value of the shares at the date of grant. There are also (generally) no income tax or social security charges upon exercise. CGT is payable on sale of the shares. Unlike the Approved CSOP and EMI, participation in an SAYE plan must be offered to all UK resident employees of the group on similar terms, although those with less than a qualifying period of service of up to five years may be excluded.
- Approved Share Incentive Plan (SIP). This is an HMRC-approved arrangement under which employees may purchase shares out of pre-tax salary or may be awarded free shares on a tax-free basis. As with the SAYE plan, participation must be offered on similar terms to all UK resident employees (with some exceptions). There are limits on the value of shares which can be purchased or awarded free in each tax year.
Various conditions apply in order for these plans to be treated as HMRC approved. These differ for each scheme. For an outline of the conditions which apply to each scheme, please ask for our information sheet on the relevant plan.
If options are granted under plans which do not satisfy the relevant conditions for tax-qualified approval, there will be no tax charge on grant, but income tax (and sometimes social security contributions) will arise upon exercise at the individual's marginal rate of tax (the top rate is currently 50 percent). This is on the difference between the market value of the shares at the time of exercise and the option exercise price (i.e., the spread).
Where shares are offered directly rather than by way of option, there will generally be an income tax charge at the individual's marginal rate of tax (and sometimes social security contributions) on the value of the shares received to the extent that such value exceeds the price paid by the employee. A special election may be entered into to prevent any later income tax charge arising as a result of restrictions which relate to the shares (for example, restrictions on transfer or which require the shares to be offered for sale on cessation of employment).
Where income tax and social security liabilities arise, it is generally the obligation of the employer to account to HMRC for such amounts (although this may not be the case for many private companies). The plan documentation should permit the employer (or parent company as the case may be) to withhold the relevant amounts from payments made to the employees.
Can a UK-approved plan be set up as part of our existing US plan or must it be stand-alone?
It is common for a UK-approved plan to be set up as a sub-plan to the main US plan rather than as a stand-alone arrangement.
The UK sub-plan is effectively set up as a schedule to the main plan but includes additional conditions which are necessary in order to obtain the beneficial UK tax treatment. In the case of a UK approved sub-plan, the schedule will also state that particular provisions of the main plan will not apply to the extent that these would prejudice obtaining UK HMRC approval.
The UK sub-plan will generally need to be approved by HMRC in advance of any awards being made under it (although approval is not necessary for an EMI plan, only that the conditions in the relevant legislation to qualify for beneficial tax treatment are met).
Are there any regulatory matters to be aware of in the UK?
The UK has implemented the EC Prospectus Directive. This requires a prospectus to be issued when shares are offered to the public. This applies to offers of securities to employees and applies to private companies as well as to publicly listed companies. The UK (along with most other EU countries) does not, however, regard the Directive as applicable to the grant or exercise of share options, nor to an offer of "free" shares to employees. It may, however, apply to an offer to employees to purchase shares, although there are a number of exemptions which may apply in such a case.
If we offer options or shares over the US entity to employees of our UK subsidiary, do we need to re-charge the cost of those awards to the UK subsidiary?
If certain conditions are met, a statutory corporation tax deduction is available to a UK employer in respect of the cost of shares acquired by its employees, whether the shares acquired are in the employer company or in the parent company of the group. In the case of a share option, the deduction is equal to the option spread. This statutory deduction is available regardless of whether or not a recharge is made to the subsidiary. Where the conditions for the statutory deduction are not met, a re-charge will be necessary in order to obtain a CT deduction and this should be made pursuant to a re-charge agreement. The amount of the re-charge may be subject to adjustment by both the UK and US authorities under transfer pricing principles.
The re-charge amount will also normally be subject to VAT in the UK under the reverse-charge procedure.
Are there any other matters we should be aware of?
Requirement for ordinary shares
If the UK sub-plan is to qualify as an approved plan for UK tax purposes, or if the UK employer wishes to claim the statutory corporation tax deduction, the subject securities must be "ordinary shares." HMRC applies a series of tests to determine whether a foreign entity has "ordinary share capital." It has confirmed, in particular, that shares in a Delaware LLC will be regarded as ordinary shares, but specific confirmation may be required in other cases. Issues can also sometimes arise where American Depositary Receipts are used.
Either the US parent or the employer, or UK host employer, must report the grant (and exercise) of options, and the acquisition of shares by employees other than by way of option. This report must be made by July 7 in the tax year following that in which the relevant event occurred.
Social security agreements and elections
As noted, UK social security liabilities will normally arise upon exercise of unapproved stock options. Such liabilities can also arise on the exercise of tax-approved options if exercise takes place outside prescribed time periods (or, in relation to EMI options, on any discount). This includes employer as well as employee social security liabilities. For stock options, it is, however, possible for the employer and employee to enter into an agreement or joint election under which the employee agrees to bear the employer's social security liability. If he does so, the employee obtains income tax relief on that amount. A joint election must be in prescribed form and have prior HMRC approval but the result is that the employer ceases to have responsibility for the employer social security liability. The alternative is a simple agreement between employer and employee: this does not require HMRC approval but the employer remains liable for any amounts the employee does not satisfy (although in practice, the employer will ensure that withholdings are made before the shares are delivered so risk should be minimal).
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