Knowing if and when you can fulfil an equity award is often just as important as making the promise in the first place.
Employers commonly promise equity to their key employees. The government is keen to encourage employee share ownership and has offered tax advantages to allow for this. When structured correctly, equity awards can align the interests of employees with shareholders and deliver tax-efficient value to employees.
Such commercial and tax benefits can, however, be jeopardised where promises of equity to employees are not formally implemented in a timely manner.
The gap between promise and award
While employers generally intend to make awards shortly after promising them, in practice, formally implementing share and option awards after their initial promise can be delayed for a variety of reasons.
The most common of these are as follows:
- Lack of management time to follow through on implementation
- Aversion to up-front set-up costs
- Negotiation of details of the awards between employee and employer
- Obtaining shareholder approval for awards
Counting the hidden costs
When equity value increases between an award being promised and implemented, this can result in higher tax charges for the employee and employer. Such an increase in value could for example be triggered by the publication of new accounts or the receipt of new investment.
In the case of HMRC tax-advantaged share plans, statutory limits for the value of awards can be exceeded if shares increase in value between initial promise and eventual implementation. This can result in part of the award being replaced by a less tax-efficient alternative.
Keeping an eye on EMI
A common example of this is where employees are promised HMRC tax-advantaged Enterprise Management Incentive (EMI) options but due to delays in implementation, the value of the shares under option does not fit within the statutory limit of £250,000 per employee.
As a result, the part of the option that exceeds the £250,000 limit is treated as a non-tax-advantaged ‘unapproved’ option. While the EMI options that were originally promised could have delivered gains at a 10% tax rate (with no NIC charge), the unapproved options have a combined tax and NIC rate of up to 47% for the employee and 13.8% for the employer.
Sense and sensitivity
The increased tax charges for the employee can be a sensitive issue if the employee considers that the delay of the awards was not of their causing. In some cases, employers agree to fund the employee’s tax on a ‘grossed-up basis’ in order to smooth out these sensitivities, but this can come at a significant financial cost to the employer.
In one instance, we have seen a delay in awarding shares cost an employer over £500,000 in additional employment taxes. In another case, we have seen delays in awards result in key members of a management team leaving to join competitors.
When and what to promise
Employers should seek advice to ensure that promises of equity are realistic and capable of being structured efficiently from a tax perspective. An initial feasibility review can ensure that the most appropriate award structure is chosen whilst setting expectations for the employer and employees.
Once award structures have been decided and equity promises have been made to employees, further advice should be sought to ensure that awards are formally implemented in both an accurate and timely manner.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.