Equity based compensation in the UK Legal update

1. Equity based compensation in the UK Legal update Janet Cooper Head of Employee Incentives Linklaters & Alliance

2. What a year! • Who should pay social security on option gains? • Will the accounting issues hold us back? • Government tries to boost employee share ownership in UK • Overview of developments in Europe • Changes to the London Stock Exchange • Impact of e-conomy

3. National Insurance • Is there a problem?

5. 1 National Insurance on option gains • What’s the problem? • since April 1999, employer pays NI at 12.2% of option gain • potentially large amount (new economy companies) • uncertainty • large and variable provisions in accounts

7. National Insurance on option gains What’s the solution? • pass this cost to employees • transfer of liability • recovery of cost • settle NI liability in advance

9. National Insurance on option gains Transfer of NI liability • effective for US GAAP • form of joint election must be approved by UK Revenue • can transfer all or part of liability

10. National Insurance on option gains Recovery of NI cost • not effective for US GAAP • liability remains with employer • informal arrangements for employee to refund cost • no approval necessary

11. National Insurance on option gains • Tax deduction for employee • 47% not 52.2% tax

12. National Insurance on option gains Accounting treatment in the UK • future liability estimated and provided for in accounts • no provision if election in place

13. National Insurance on option gains So what’s to be done …. Ask • is the company prepared to pick up cost? • how will it look in accounts? • do you want to transfer liability?

14. National Insurance on option gains To transfer liability • look at plan rules • prepare letter and agreement • get Inland Revenue approval • speak to accountants

15. Accounting for share-based payments • UK, Australia, Canada, New Zealand and US ASBs 2 Accounting for share-based payments • “cost” of options should be recognised in company accounts • heard this before?

16. Accounting for share-based payments IASBs’ reason for change: • Company is receiving value of services • Accounts should reflect cost of this “transaction” • Not happening under current rules

17. Accounting for share-based payments IASBs’ proposals: • “Fair” value should be charged • Include existing shares as well as new issue shares • Includes share-based payments to non-employees Danger - might make options too “expensive” for some companies

18. Accounting for share-based payments What’s “fair” value? • Calculated using option pricing model (eg Black Scholes) • Fair value to be determined at vesting • But: • options not transferable • what about unlisted companies?

19. Accounting for share-based payments What’s the accounting period? • Charge to be spread over performance or vesting period • Adjustments to be made to reflect • likelihood of vesting and • changes in option “value”

20. Accounting for share-based payments Financial impact • double hit to shareholders • some companies become insolvent overnight • makes share awards/options very unattractive • lose edge in “war for talent”?

21. Accounting for share-based payments Proposals are wrong • Options are incentives not salary • Cost is a dilution cost to shareholders not a profit cost • Valuation methods arbitrary and unrealistic

22. Accounting for share based payments Keep very close eye on your ASB! These proposals are coming your way

23. 3 Budget 2000 and 2001 Boost for share ownership? • 2 new qualifying plans for UK employees • Greater taper relief on capital gains

24. New qualifying all employee share ownership plan • Flexible - free, partnership and matching shares (no options) • To be offered to all UK employees • Can be related to performance • But administration burdensome • Tax benefits if shares held for 5 years

25. EMI options • Aimed to help small entrepreneurial companies recruit and retain • Up to £100,000 options tax free for each of 15 key employees • No approval procedure

26. EMI options BUT company must: • have gross assets of less than £15m (~$23m) • be independent • be trading in the UK

27. EMI options Changes announced this November • remove limit of 15 employees • increase value limit to £2.5m

28. CGT taper relief • Capital gains tax decreases the longer shares are held • 2000 Budget - taper relief for all employee shareholders • Effective CGT is 10% on gain if shares held for 4 years!

29. 4 Overview of developments in Europe • France • Holland • Germany • Italy • Spain

30. Holland • Germany • France • Spain • Italy

31. Tax on Options - Europe

32. 5 London Stock Exchange • Demutualised and listed to become London Stock Exchange plc • To avoid conflict, regulatory work now under Financial Services Authority • Admission to listing and trading now separate

33. London Stock Exchange Merger story • Talks with Frankfurt Deutsche Börse exchange to form iX-international • OM Group announces hostile bid • LSE withdraws from iX talks • LSE publishes defence to OM bid • OM bid fails • What next? Link with NASDAQ?

34. 6 Impact of new e-conomy • More flexible/shorter vesting • No performance conditions • Challenges to corporate governance guidelines

35. Impact of new e-conomy War for talent • Global battleground • Changing views of institutions?

36. Impact of new e-conomy dot.corps • New incentive design challenges • Technical challenges • Institutional investor relations

37. So, in 2000…..

38. Good news - new plans, help on NI costs • Keep an eye out for future options lobbying • Bad news - accounting for options …….. what about 2001?

39. Thank you