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Share Schemes Training Session for HMRC Shares Valuation

Share Schemes Training Session for HMRC Shares Valuation. At HMRC Nottingham. Pett, Franklin & Co LLP. 7 th May 2014. Timetable. UK Share Schemes Overview. 7 th May 2014. David Pett Partner www.pettfranklin.com. Introductions. Pett, Franklin & Co LLP David Pett William Franklin

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Share Schemes Training Session for HMRC Shares Valuation

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  1. Share Schemes Training Sessionfor HMRC Shares Valuation At HMRC Nottingham Pett, Franklin & Co LLP 7th May 2014

  2. Timetable

  3. UK Share Schemes Overview 7th May 2014 David Pett Partner www.pettfranklin.com

  4. Introductions • Pett, Franklin & Co LLP David Pett William Franklin Stephen Woodhouse • ‘the Book’ : “Employee Share Schemes” (2-vol looseleaf, pub. Sweet & Maxwell) • The market for advice and implementation assistance • lawyers vs accountants vs ‘consultants’ • the roles of : Share Plan Lawyers’ Group ifsProShare Efes The Esop Centre Employee Ownership Association (“EOA”) • tax/company law/employment law/securities laws/trust laws • Largely separate administration industry including offshore trustees www.pettfranklin.com

  5. (Recent) legislative history • 1980: SAYE share options • 2000: EMI share options and Share Incentive Plans • 2003: Tax law re-write .... immediately followed by: • change to charging rules for unapproved schemes and arrangements • MoUs re valuation of ‘management shares’ and ‘carried interests’ • ‘opportunistic’ (ab)use of ERS....tax-free bankers’ bonuses; ‘employees’ trusts’ used to warehouse funds free of PAYE • 2010: Disguised Remuneration : was this the right response ...? • 2013: • OTS reports on approved and unapproved schemes • ‘Shares-for-Rights’ – Geo. Osborne’s idea • the Nuttall Review of Employee Ownership • myriad technical ‘relaxations’ of rules re SIPs, CSOPs, SAYE • ER for EMI option shares • 2014: E-filing/registration and further technical changes (eg re takeovers) www.pettfranklin.com

  6. Practical commercial difficulties • Avoiding a ‘dry’ tax charge : ERS are charged to IT when acquired, even if they are not immediately convertible into cash (OTS proposal?) • Are the shares ‘readily convertible assets’ ? (if the co not independent, they will always be RCAs) • ‘founders’ shares’ – are the shares acquired by reason of an opportunity in the course of a personal relationship ? (s421B(3)) • Is it a ‘close company’ ? • Assessing ‘hope value’ - the ‘information standard’ (MORE LATER) • ‘Restricted’ shares : • inherent characteristics of a share vs restrictions • UMV vs AMV (given that a s431(1) election has become the universal ‘default’ option) • the ‘10% rule’ ? • Companies operating an ‘internal market’ – who determines MV ? www.pettfranklin.com

  7. Unquoted companies Allowing employees to benefit from future growth in value EMI options: if you qualify, is it a ‘no brainer’ ? but what of ‘Shares-for-Rights’ ? ‘unapproved’ share options Joint Share Ownership (“JSOP”) awards (so-called)‘growth shares’ ? www.pettfranklin.com

  8. Is an ERS acquisition taxed as a “right to acquire shares” ?...or as an acquisition of ERS at an undervalue ? • of concern to internationally mobile employees • Is it a ‘general earnings charge’, or a Part 7 charge ? • different rules apply www.pettfranklin.com

  9. Why is it so complex ? Example: Private company owned by H & W wishes to allow a key employee to benefit from growth in c. 9% of company; If co grants EMI option to subscribe for shares, exercised after 3 years, how does employee realise the growth in value ? A sale back to the co will give rise to a ‘dividend tax’ charge on the growth in value Co sets up an employees’ trust to buy back shares, but a loan to the trust attracts a penal 25% tax charge ! If co buys back from employee, he gets CGT with ER, but if co then buys back from trust, deemed MV CGT charge on trust ! So, have to have (a) an upfront issue of the shares to an offshore trust at par using small loan (with 25% tax); (b) a contingent purchase contract (under CA 2006) to buy back shares from trust at par; (c) a cash contribution to fund the buyback by trust from the employee [co gets CT deduction for share option gain, not cash contribution] www.pettfranklin.com

  10. So, we need one more ‘tweak’…… • Allow employee shares to be repurchased by the company itself with no dividend tax penalty if bought back within 5 years • avoids need for an offshore employees’ trust • it would allow an SME to: • grant EMI options • secure CT relief for option gain • buy back shares out of reserves into treasury • thereby ‘ringfence’ employee shares • Please support the lobbying for change….! www.pettfranklin.com

  11. Participation in future growth in value can be achieved by : grant and exercise of 'market value' share options (EMI options; CSOP options; 'unapproved' share options) the creation and issue of a special class of 'growth shares' allowing the employee to acquire an interest as 'joint beneficial owner' on unequal terms under a JSOP ('joint ownership') a ‘founders’ SIP’ ? www.pettfranklin.com

  12. ‘Employee Shareholder’ status (“SFR”): key Features Employee is issued with fully-paid shares in employer company (or holding company) worth at least £2,000 (after taking account of restrictions) for no consideration other than entering into a written ‘employee shareholder agreement’ Employee treated as paying £2,000 (so first £2,000 of value is exempt from income tax and NICs) Insofar as the initial value, ignoring restrictions (IUMV), does not exceed £50,000, gain on sale is completely free of capital gains tax Better than EMI where gain is taxed as capital gain, albeit normally with reduced 10% ER rate www.pettfranklin.com

  13. ‘Employee Shareholder’ status: key Features Employee has to forego certain key statutory employment rights Must be a written ‘employee shareholder agreement’ Before agreement becomes effective, the employee must receive Independent Advice (paid by employer) and there must be a 7-day ‘cooling-off’ period www.pettfranklin.com

  14. “Employee shareholder status”(or “Shares for Rights” ) • shares can be in employer company or a parent undertaking • issuing company does not need to be independent ! • of particular attraction to PE-backed companies • no exemptions if employee has a ‘material interest’ (25% voting rights) or, if a close company, 25% of assets on distribution, winding-up (etc.) at, or within 1 year before, issue of employee shareholder shares • no IT/NICs on acquisition/on first £2,000 of AMV • should company pay cash bonus to cover par value plus IT/NICs ? www.pettfranklin.com

  15. Advantages of SFR Within a limit, gain is completely free of capital gains tax Shares can be restricted/special class - but this reduces the IAMV Shares can be in a subsidiary May be offered on a discretionary basis www.pettfranklin.com

  16. Disadvantages of SFR Statutory employment rights foregone (but rights under contract remain) Upfront tax charge (but first £2,000 tax free and value can be agreed in advance, so tax known) Lower limit for CGT relief (£50,000 compared with £250,000 for EMI) Shares must be issued (so cannot use EBT shares)... ...for no consideration (other than giving up employment rights) Company law problems www.pettfranklin.com

  17. Relief on sale back to company A sale back to the issuing company (for cancellation or to be held in treasury) is exempt from dividend treatment (even if the shares were not held for 5 years) but only if sold after the employee no longer a director or employee of that or any associated company Beware: gain on sale-back by continuing employee to issuing company is taxed as dividend income if shares not held for 5 years (etc) www.pettfranklin.com

  18. JSOPs: a summary Not share awards; not options Employee jointly acquires shares with co-owner (usually a trust) Held under terms of JOA Proceeds of sale unequal Employee receives growth (less carry charge) Co-owner receives the balance Capital gains treatment for employee (like EMI) Performance link www.pettfranklin.com

  19. £ Employee’s gain Tax point [ 2] % p.a. ‘Carrying’ Cost ‘Threshold amount’ Co-owner’s gain Acquisition Sale 3 years www.pettfranklin.com

  20. JSOP Benefits Growth taxed as capital not income Employee pays tax at 28 % not 40 %+ Company saves NICs 13.8 % Tax analysis repeatedly publicly accepted by HMRC Flexible Same treatment as other shareholders on takeovers www.pettfranklin.com

  21. JSOP Issues Shares in existence from start (hence carry charge) Surplus shares trapped in conventional EBT if performance condition fails (use GPT) Close company loans to EBT No CT relief on growth Upfront cost of participation based on initial market value of employee’s interest (IUMV) Need to fix carry charge in advance www.pettfranklin.com

  22. When is a JSOP appropriate? If EMI options not available Share value meaningful (or not certain that HMRC will agree its not meaningful) IUMV sufficiently low for upfront cost to be economically feasible Growth prospects; if share price can only fall or flat line not much point as employee gets nothing www.pettfranklin.com

  23. Comparison of 'growth shares' and JSOPs • 'growth shares' require changes to the articles, but a JSOP is all in contract, so easier documentation; • JSOPs require a 'joint beneficial owner' : an EBT or GPT • Guernsey Purpose Trust allows surplus assets to be returned to company • easier to administer JSOPs on a corporate transaction/'exit event' www.pettfranklin.com

  24. There are plenty of reliefs/exemptions for employee share acquisitions EMIs/CSOPs/SAYE share options; "Shares-for-Rights'; Share Incentive Plans …but not so many upon a disposal of employee shares : 'Shares-for-Rights' Share Incentive Plans ER for EMI option shares www.pettfranklin.com

  25. Changes in 2013 for SIPs • OTS report on tax-advantaged share schemes • nearly all recommendations accepted • Removal of pitfalls: • no ‘material interest’ test • removal of the penal clawback if company sold within 3 years for cash • freedom to use restricted shares – but restrictions ignored for valuation purposes • restrictions on transfer • good/bad leaver provisions • can be non- voting • removal of need for a specified retirement age www.pettfranklin.com

  26. What if the company is sold ? • From 17 July 2013 • No tax on a withdrawal and sale of SIP shares pursuant to: • general offer to acquire control • a takeover offer (not defined) • a scheme of arrangement • In consequence of which the participant receives cash (only) for SIP shares • Must not be an alternative ‘shares- for – shares’ exchange on offer • Avoids any risk of clawback if company sold early www.pettfranklin.com

  27. Changes in 2014 to SIPs • self certification/registration from 6 April 2014 • increases in limits on tax-free shares • Free shares £3,000 to £3,600 • Partnership shares £1,500 to £1,800 • Matching shares ( 2 for 1) £6,000 to £7,200 • Dividend reinvestment (already no limit) • annual returns to HMRC to be made electronically • Partnership shares: may allow obligation to sell on leaving for at least amount of money used to buy Partnership shares (or MV, if less) • new rules for enquiries and appeals www.pettfranklin.com

  28. New registration and self-certification regime from 6 April 2014 • To qualify for tax reliefs, every CSOP, SAYE scheme and SIP must be registered with HMRC through PAYE Online Services • registration can only be done by a person with full access rights • Existing schemes/plans must be registered before 6 July 2015 • All EMI plans and all unapproved schemes or arrangements must likewise be registered • EMI grants must be notified online • Annual returns must be online www.pettfranklin.com

  29. Advantages of a SIP for founders (as against “growth shares”) • Standard-form documentation • Growth in value of “Founders” plan shares is entirely free of tax (exempt from CGT) • Non-SIP shares probably entirely tax-free because of CGT nil-rate band • Relative ease of administration • Can normally be undertaken in-house • GAAR? www.pettfranklin.com

  30. Restricted Shares • Problem: • pre-emption of SIP shares of leavers had to apply to all shares of the class forcing an existing non-SIP shareholder employee to sell • New regime: • shares can be subject to restrictions which only apply to SIP shareholders www.pettfranklin.com

  31. Employee-ownership Trusts Exemption from CGT if individual (or trustee) proprietors sell a controlling interest to a new-style Employee-ownership Trust (“EOT”) If a sufficient number of unconnected employees, vendors can retain up to 49% and rights to all dividends Can use company’s own funds to purchase the shares If company is later sold, a ‘clawback’ charge to CGT is levied on the EOT trustee, not the vendor(s) To avoid clawback, the EOT must retain indefinitely at least a 51% controlling interest www.pettfranklin.com

  32. Conditions for CGT exemption on sale to an EOT • The company is a trading company (or holding co. of a trading group) • the trust only allows benefits on an ‘all-employee/same terms’ basis • the trust acquires a 51% controlling interest by the end of the same tax year • the ‘limited participation requirement’ is met • the disposals (if more than one) must all be in the same tax year www.pettfranklin.com

  33. Employee-ownership Trusts Relief from IhT if C, being a close company, makes a ‘gift’ of, say, cash to an EOT to fund the share purchase in the same tax year No relief from ‘loans to participators’ charge under s455 CTA 2010 on a loan by a close company to an EOT May still need a s701 ITA (“transactions in securities”) clearance if the EOT not acquiring at least a 75 per cent interest www.pettfranklin.com

  34. Owner EOT sells ≥ 51% of shares to EOT 51% Note: Vendor can retain up to 49% (and 100% of dividends, if EOT trustees waive their dividends) provided the ‘limited participation’ requirement is met 49% Hold Co 100% Trading Co www.pettfranklin.com

  35. The “limited participation” requirement (s236N) NP must not exceed 2/5ths or 40% NE NP = no. of 5%+ ‘participators’ (shareholders or loan creditors) who remain employees or directors (etc) (+ connected employees or directors) NE = no. of group employees www.pettfranklin.com

  36. Example: So, vendors (H & W ?) could retain up to 49% of share capital PROVIDED THAT (if they are the only participators who remain employees or directors, and they have no ‘connected persons’ who are directors or employees) the number of group employees is at least 6 (including H & W) If H retains at least 5% and W, son and daughter are employees (but have no shares), there must be at least 7 other employees (4 + 7 = 11; 4/11 exceeds 2/5ths) www.pettfranklin.com

  37. Employee-ownership Trust An EOT must: • only ever allow the fund to be applied for the benefit of all eligible employees on a “same terms” basis and so that all eligible employees then receive benefit • may allow 12-month qualifying period • must exclude existing and former 5% participators and their ‘connected persons’ • not allow the creation of any trust of the fund, or making of loans or by transferring property to another settlement (except another EOT) • not include any possibility of amending the trust so as not to satisfy these requirements www.pettfranklin.com

  38. Clawback of relief ........ occurs if there is a “disqualifying event”, but the clawback charge is on the trustees, not the vendor “Disqualifying event” is: • ceasing to be a trading company (etc) • the trust ceases to hold a 51% controlling interest • the participator fraction exceeds 2/5ths • trustees breach the ‘all-employee’ benefit requirements • Immediate disposal and re-acquisition at market value • [What if the EOT trustees are non-UK ? ] www.pettfranklin.com

  39. “Employee Ownership Trusts” B. Relief from income tax on employee bonus payments Qualifying bonuses of up to £3,600 paid to all qualifying employees on a “same terms” basis will be exempt from income tax (but not NICs) Only available if the company is owned by an “Employee Ownership Trust” May differentiate on a linear basis according to length of service, salary level and/or hours worked From 1 October 2014 www.pettfranklin.com

  40. Tax-free bonuses paid to all-employees of an EOT-owned company Must be a ‘bonus’ payment by the employer company Must be paid on a ‘same terms’ basis to all eligible group employees and not to only those in a particular member or function Employer must not be a ‘service company’ (ie providing services outside the group) or a ‘managed service company’ No. of office holders (+ connected persons) as fraction of all employees + office holders must not exceed 2/5ths Must be no “salary sacrifice” arrangements www.pettfranklin.com

  41. EMIBenefits and Requirements 7th May 2014 Stephen Woodhouse Partner www.pettfranklin.com Pett Franklin/HMRC Seminar

  42. Target Companies Small companies (defined by reference to maximum £30m of gross assets) Typically owner managed due to independence requirement May also apply for certain private equity backed companies with no 51% corporate shareholder www.pettfranklin.com

  43. Tax Benefits No tax or NIC charges on grant of options No tax or NIC charges on exercise of options if exercise price no less than MV on grant Corporation Tax relief on exercise on intrinsic value on exercise (if relevant conditions for CT relief are fulfilled) CGT on sale but potential for entrepreneur’s relief to reduce effective rate to 10% www.pettfranklin.com

  44. Tax Benefits www.pettfranklin.com

  45. Main Requirements: Value Limits Legislation in Sch 5 of ITEPA Para 4 – must be granted for “commercial reasons” to “recruit or retain” an employee and not for tax avoidance Para 5 – employee may not hold an option in respect of shares worth more than £250k by reason of employment with one company or group; Option over excess value is not a qualifying option in relation to the excess Measurement of value includes value of CSOP options www.pettfranklin.com

  46. Main Requirements: Value Limits • For these purposes: • Value = “market value, at the time when the option is or was granted, of issued shares of the same class as those that may be acquired by exercise of the option” • Market value is CGT definition (Para 55) but ignoring restrictions (Para 5(8)) • £250k limit extends over three years (Para 6) www.pettfranklin.com

  47. Main Requirements: Value Limits Para 7 – total value of shares subject to unexercised options must not exceed £3m (applying same valuation rules as for £250k limit) www.pettfranklin.com

  48. Qualifying Companies: Independence Para 9 = not a 51% subsidiary or controlled by (a) another company or (b) another company and any connected person No arrangements to become such a subsidiary or fall under such control (other than arrangements for a “qualifying exchange of shares” – i.e. a share for share exchange in the context of a reorganisation www.pettfranklin.com

  49. Qualifying Subsidiaries • Para 10 - all subsidiaries must be “qualifying” if parent is to issue EMI options • Subsidiary is any company which parent controls either on its or with any person connected with it (applying close company control test) • Qualifying subsidiary requirement is that subsidiary is: • 51% subsidiary of parent • No person other than parent controls the subsidiary • No arrangements are in existence by virtue of which either of the first two conditions would cease to be met • Also, parent must not have a “property managing subsidiary which is not a 90% subsidiary (paras 11A and 11B) www.pettfranklin.com

  50. Gross Assets/Number of Employees • Gross Assets Test (Para 12) • Gross assets of a single company do not exceed £30m at date of grant) • With a group, the gross assets test applies to the aggregate gross assets of each member of the group, disregarding any intra-group assets or shares or securities in other group members • Looking at gross assets shown in the accounts – can catch small companies with unusual accounting conventions (e.g. insurance brokers with client money) www.pettfranklin.com

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