UK: Employee Share Schemes - Going Global

You’re a UK company considering extending your employee share scheme worldwide. How do you go about it? What are the issues? What are the costs?

Many companies extend their employee share schemes overseas. For some, the rationale is for employees to realise that they are part of a business wider than just their local operation. A global employee share scheme helps develop a worldwide corporate identity. For others, introducing a global employee share scheme enables gain sharing (i.e. participation in a company’s financial success) to be distributed widely. Yet others cite the need to have a level playing field worldwide in terms of the benefits they offer to their employees.

Let’s assume that a company has already got approval for an existing UK share scheme. Is the original shareholder approval wide enough to allow further schemes to be established for overseas employees?

Many companies include an authority at the time of establishing a UK plan to establish further plans which are modified to take account of local tax, exchange control or securities laws in overseas jurisdictions. Clearly, the position needs to be confirmed on a case-by-case basis.

Like any commercial operation, you need to do your "due diligence" to assess the position. Advice is needed for each country to which the scheme is to extend on local securities laws, tax implications (corporate and individual), exchange control regulations, withholding and reporting tax and labour law. Armed with this information, you can then establish whether the scheme is feasible in practical terms, the cost of using your scheme to incentivise employees worldwide and the benefit to the employees.

Information on the current status of securities, exchange control and tax laws (together with any other applicable laws) will be required from local advisers. The easiest way to do this is for Herbert Smith to produce a standard format questionnaire using our international database. We simply require the information to be confirmed by overseas advisers (using our network of international offices, associated firms and other advisers with whom we have worked in the past). This approach saves both time and (quite dramatically so) overseas advisers’ fees.

Investor protection legislation requiring a prospectus to be produced on a "public offering" of securities is widespread, and failure to comply can result not only in financial penalties, but also in claims by participants against the company (on the grounds that the risks of share ownership were never fully disclosed to participants, i.e. that investments can go down as well as up!).

While prospectus requirements are widespread, they do vary in stringency with many jurisdictions having exemptions for employee share schemes or for small public offerings of securities. The range of possible prospectus requirements is as follows:

• a prospectus is required because the scheme is deemed to constitute an offer to the public;
• a prospectus is required in principle for the scheme because the scheme is deemed to constitute an offer to the public but not if the offer is restricted to a certain number of people or a certain value of securities;
• a prospectus is again in principle required, but it is possible to apply to the local regulator for an exemption;
• a statutory exemption is available for the scheme;
• the prospectus rules only require the filing of certain papers; or
• no relevant investor protection legislation exists.

Don’t forget, you need to check the securities law position not just at the time of grant but also upon exercise or upon the disposal of any resulting shares.

In a situation where a prospectus is required, cost becomes a primary issue. The production cost of a new prospectus complying with the requirements of local law can be prohibitive unless large numbers of employees are employed locally and it is absolutely crucial that shares (rather than cash awards) should be offered.

Companies faced with the cost of producing a prospectus usually consider:

• the use of a "wraparound" prospectus (i.e. a short appendix to an existing UK circular); or
• the grant of phantom options (i.e. rights to cash or free shares).

A wraparound prospectus may be a viable solution, although it is only available where the company has recently issued a circular in the UK containing all or most of the information required by the local prospectus rules. Where a wraparound prospectus is a possibility, the costs associated with producing a prospectus can be significantly reduced. An alternative solution would be to avoid the prospectus rules altogether by granting phantom options, which provide for the right to receive cash (or sometimes free shares) rather than purchasing shares under conventional options.

After securities laws issues, the next important issue to address is when the tax charge arises for the employee. Clearly, you wouldn’t want to crystallise a tax charge for an employee at a time when shares can’t be sold to fund this liability or when there are no other ways of funding the liability.

When considering the issue of local taxation, companies operating international executive share plans are usually concerned to avoid tax on the grant of options (at which point the employee does not yet have any shares which could be sold to meet the tax charge). Most countries do not tax on grant but some key jurisdictions do (e.g. Belgium). In other jurisdictions, a tax payer can elect to be taxed at the date of grant.

In most countries, options are subject to income tax on exercise. This is regarded as a reasonable position, in that the employee can sell shares at that stage to pay the tax.

In certain countries (e.g. Brazil) no tax arises until shares are sold or even at all (e.g. the United Arab Emirates). In other countries, the structure of the arrangement can affect the tax treatment.

Are there any arrangements which can achieve tax benefits for the employee without making any fundamental changes to the key features of the scheme?

Local legislation providing for tax-approved schemes is relatively rare. Countries providing favourable fiscal treatment for certain employee share schemes include:

• the UK – approved options (CSOP, SAYE and SIP), taper relief;
• the US (where incentive stock options can be granted which give better individual tax treatment for the individual but a worse tax outcome for the employer in that the normal automatic tax deduction is denied);
• France – approved options which have a better tax and social security outcome for both the executive and the company;
• Italy – non-discounted options give rise to a rate of tax of only 12.5% and no social security liabilities provided you can show that the options were granted at "normal value" for the purposes of the Italian Tax Code;
• Ireland – approved SAYE options can now be granted in addition to using approved profit sharing arrangements; and
• Australia – the executive can elect to be taxed upon grant and if the shares acquired on exercise are held for long enough, the chargeable gain on disposal is reduced by 50%.

Exchange controls present difficulties for employees who need to pay an exercise price to acquire shares. This is a situation in which money is payable by the employee and may result in a flow of funds out of the foreign country, triggering exchange controls. There are various possible solutions:

• domestic legislation may allow for the outflow of money, provided that funds are repatriated within a short period (i.e. by the immediate sale of the shares purchased);
• some exchange control regulations also allow an employee to hold assets up to a certain value abroad;
• phantom options can be granted. On exercise of the phantom options, the employee would be paid cash (i.e. an inflow rather than outflow of funds to the country concerned) or would receive free shares; or
• real share options could be granted, but with a "cashless exercise" facility.

The key questions to ask are:

• will either the parent company or the employing company or the employee have any reporting requirements as a result of the scheme on the date of grant or the date of exercise?
• how will the employee’s tax and social security be collected? Will the employee be responsible for paying any liabilities or will the employing company be responsible for paying tax or social security liabilities on the employee’s behalf?
• if the employing company is responsible for the employee’s liabilities, can the company withhold the liabilities out of salary?
• if the employee’s salary in the month of exercise is not sufficient for the employing company to withhold all of the executive’s liabilities, can the parent arrange for the employee to authorise the parent to sell shares in the market and pass the money to the employing company? Would this arrangement give rise to any issues in the relevant jurisdiction?

Under domestic labour law do you need to enter into consultation with local trade unions or employee representatives? This is a particular feature of the German system, which provides that a local employer must inform the "works council" about a proposed scheme. However, in practice, the requirement is of minimal consequence for UK companies as it is generally possible to structure employee benefits so that they are paid by the UK parent company rather than the German employer. Furthermore, depending on the number of employees involved, there may be no actual requirement to consult with the trade unions.

Among the main administrative tasks which must be dealt with before launching a scheme overseas are to obtain information about the identity and location of participating employees (including their tax details), developing a system for maintaining and up-dating that information (including dealing with leavers), establishing an effective document distribution and return system and ensuring that communications are both clear and effective.

Whenever possible, it’s a good idea to devolve administration of a scheme to local management and for them to coordinate the launch of a scheme in their own jurisdiction.

Communications will need to be kept under review and, where appropriate, updated. The company needs to decide what information should be communicated to employees (including whether local translations are necessary).

It’s very common for a company to spend a great deal of effort in establishing a plan only to lose interest in it immediately after the launch. This is, of course, a big mistake. Apart from ongoing reporting and withholding requirements, it’s likely that a successful scheme will be launched on an annual basis. Clearly, the due diligence exercise needs to be repeated on a regular basis although, in order to save costs, it should be possible to approach the local advisors with previous advice and simply ask them to confirm that it has not changed or, where appropriate, to advise accordingly.

"© Herbert Smith 2002

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