Incentives and Remuneration: Spring Update

From 6 April 2023, the maximum value of shares an individual can hold under CSOP options has doubled from £30,000 to £60,000 (calculated by reference to the value of the shares at the time of grant).  Although this is still significantly below the £250,000 limit applicable to Enterprise Management Incentives (EMI), the increase is welcome news for companies operating CSOP plans.  The previous limit, which had not changed for nearly 30 years, was soon reached by employees and companies had to grant anything above it as unapproved options (with all the associated PAYE and NICs costs this entails). 

Also, CSOP is now accessible to a wider range of companies because the rules on the shares that can be used for options have been relaxed.   Previously, companies with more than one class of ordinary share could only grant CSOP options over the class that either gave employees control of the company or was majority held by non-employees.  This restriction was designed to ensure that CSOP options were granted over shares that HMRC considered "worth having" but, in fact, prevented many private companies from granting CSOP options altogether.  From 6 April this rule has been removed, meaning that companies are now able to grant CSOP options over any ordinary class of share for employees, including so called 'growth shares', should they wish to. 

The changes apply to options in existence on 6 April that have not yet been exercised as well as those granted on or after that date.  As they take effect automatically, companies won't need to amend their plan rules to take advantage of these changes. However, to avoid confusion to the reader, it is always a good idea to make sure your plan rules are up to date and now would also be a good time for a general health-check.  Similarly, any employee-facing documents such as guides, or Q&A booklets should be reviewed and up-dated if required.

If you operate both EMI and CSOP plans, it is important to remember that you must take unexercised CSOP options into account when calculating the £250,000 individual limit for EMI. If you grant CSOP options to an EMI option holder which will take them over this £250,000 limit (in aggregate) the EMI award is at risk of losing its tax benefits.

For example:  If an employee holds an EMI option over shares worth £220,000 and a CSOP option over shares worth £30,000, the aggregate limit of £250,000 for EMI purposes is satisfied and all options are tax-favoured.  If, after 6 April 2023, the employee is granted an additional CSOP option over £30,000 shares, this will cause the aggregate limit for EMI purposes to be exceeded by £30,000.  The CSOP options will remain tax-favoured, however, the EMI options could lose their beneficial EMI treatment.  

Improvements to the EMI option grant process

Although the Government has decided that the Enterprise Management Incentive (EMI) plan works well as it is and does not need fundamental changes, the Budget included some welcome announcements to improve the option grant process.  These should help reduce the situations in which tax relief is lost due to administrative errors. 

In March 2021, the Government launched a Call for Evidence on Enterprise Management Incentives as part of its review into whether the plan was reaching the right companies and meeting its aims.  Following that review, the Government concluded that EMI is working well and does not require any fundamental changes.  However, to relieve the administrative burden that the Government recognises is placed on companies when granting EMI options, in the March Budget three key reforms were announced:

• Requirement to set out share restrictions in option agreements removed

Details of any restrictions attaching to option shares had to be set out in the EMI option agreement itself.  There was previously a lack of clarity as to how this obligation could be met, creating uncertainty as to whether some options qualified as EMI.  To ease this burden, from 6 April, the requirement to expressly set out any restrictions attaching to the shares in the EMI option agreement was removed.  This change applies to existing (but not yet exercised) EMI options as well as those granted on or after 6 April.  We await further HMRC guidance on whether restrictions will still need to be notified to EMI participants (and by what means).

• Requirement for a signed working time declaration removed

Another aspect of the EMI grant process that caused difficulties was showing that a signed working time declaration had been obtained from the relevant employees.  Employees used to have to sign a declaration confirming that they work for their employing company for at least 25 hours a week or, if less, 75% of their working time.  If the employee failed to sign this declaration, the award granted to them was technically not an EMI option even if, as a matter of practice, they had worked the required hours.  Recognising that this could lead to some harsh consequences, from 6 April the requirement for an employee to sign a working time declaration has been removed. Again, this applies to existing but unexercised options as well as those granted on or after 6 April.  It is important to note, however, that the working time requirement itself remains and companies still need to satisfy themselves that it is met and keep a record of this.

• Date for notification of EMI option grant to be extended

The final announcement relates to the date by which companies must notify the grant of an EMI option and will not take effect until the 2024/25 tax year.  Currently, an EMI option must be electronically notified to HMRC within 92 days of grant.  This 92-day notification requirement does not apply to any other tax-advantaged share options.  From 6 April 2024, the deadline will be extended to 6 July following the end of the tax year of grant to bring EMI notifications in line with the annual return deadlines for EMI and all other employee share plans.  We understand that the legislation to implement this will be introduced at a later date.

These changes are welcome news for all companies operating an EMI plan and should ease the administrative burden on companies when granting EMI options as well as reducing the uncertainty of how to treat the exercise of EMI options.

Enterprise Management Incentive (EMI) plans are a very attractive way of granting share options to employees in terms of their flexibility and the tax benefits they can provide. However, EMI presents something of a contradiction; on the one hand it was designed in such a way that smaller "growth" companies should be able to implement and operate EMI without seeking legal advice and yet, on the other hand, it requires careful analysis of some complicated issues to check that all the qualifying conditions are met.  One such complicated issue is the use of discretion.

When a company establishes an EMI plan, there are likely to be circumstances where it will want to decide whether and to what extent an EMI can be exercised as and when the situation arises, most commonly when someone leaves or when there is a corporate event.  It has generally been understood that HMRC want to see that the option holder has a clearly enforceable right to acquire shares, that the situations in which any discretion can be exercised are clear from the outset and that the exercise of the discretion doesn't amount to the creation of a new right.  In recent months, some uncertainty has grown over what HMRC's view was. To remedy this, helpful new guidance has been published together with some useful examples of the most common fact patterns we see in practice.

The reduction in the annual CGT exempt amount (down to £6,000 from £12,300 on 6 April and then halved again to £3,000 from 6 April 2024 onwards) is unwelcome news for participants in tax-advantaged share option plans. This is because many of them have been able to use the allowance against gains realised when they sell their option shares to make participation in the plan effectively tax free. Some participants can transfer their shares to a spouse or civil partner first, to take advantage of double the allowance. The same issues arise for participants in share incentive arrangements that are not tax favoured but benefit from capital gains tax treatment.

Whilst there is no obligation on companies to do so, sending a reminder of these changes to their share plan participants  (whilst being careful not to give personal tax advice) would be useful.  

If an employee's right to participate in a share plan transfers under TUPE, this can create practical difficulties for the new employer.  Transferring employees can't participate in the former employer's scheme once they have moved, and the new employer might not be able to put in place an identical scheme so it may have to offer something which is "substantially equivalent". The point was considered in the employment tribunal case of Ponticelli UK Ltd v Gallagher where the employee in question participated in an all-employee tax advantaged share incentive plan with his employer under which he was able to acquire shares in the employer's parent company. The plan was not mentioned in the individual's employment contract and the plan itself stated that it was non-contractual. The employee's employment transferred under TUPE to a new employer. The new employer said that it was not going to provide an all-employee share incentive plan but that employees would instead receive a one-off payment as compensation. However, the employee applied to the employment tribunal for a ruling that they were entitled to participate in an equivalent share incentive plan with the new employer.

The Employment Appeal Tribunal ruled that the share incentive plan was part of the employee's overall financial package as an employee. Even though it was non-contractual, it arose "in connection with" the employee's contract of employment and therefore transferred under TUPE. Accordingly, the new employer was required to put in place a share incentive scheme that was substantially equivalent to the old scheme.

This case demonstrates that benefits like a share scheme can transfer under TUPE even if they are not contractual, as they could be considered as arising "in connection with" the employment contract. In many cases, the new employer should have the right to terminate a share scheme which transfers under TUPE. Where a share scheme transfers, it does so on its existing terms. If, as is usually the case, the terms of the plan gave the former employer the right to amend or withdraw it, then the same right would arguably apply to the new employer.