Employee share schemes remain a cornerstone of remuneration planning, but seemingly minor oversights in documentation, compliance or valuation can undermine the incentives and tax advantages they intend to deliver.
ERS compliance: why this should never be an afterthought
Whenever employees or directors receive shares or interests in shares, the employment‑related securities (ERS) reporting regime should be front and centre of a company’s regular compliance processes.
Failing to keep on top of annual and in-year ERS reporting, making incorrect filings (or none at all), or missing the 6th July deadline for submissions can lead to difficulties further down the line – particularly when the company in question is subject to a due diligence or audit exercise.
For tax advantaged share schemes, failure to comply with ERS requirements can result in the loss of tax-efficient status and give rise to unexpected income tax and NIC liabilities.
Crucially, ERS obligations are not limited to “headline” share awards. Less obvious award arrangements – such as growth shares, nil paid shares, restricted securities, or shares issued in lieu of fees or bonuses – can also trigger immediate and ongoing ERS reporting requirements, making early identification and accurate reporting essential.
Discretion: flexibility with consequences
Discretion clauses are commonly included in share plans to provide flexibility around vesting, leaver treatment and exit‑related events. Used carefully, they are a useful tool to give schemes flexibility to adapt to real‑world scenarios which may not have been contemplated at adoption or grant.
Where discretion can be problematic is in the context of HMRC approved schemes – particularly Enterprise Management Incentive (EMI) schemes. HMRC’s guidance draws fine distinctions between acceptable uses of discretion without any adverse tax consequences, and use of discretion which is enough to be treated as a surrender and re-grant of an option on new terms.
As the qualifying conditions for EMI options are tested at the time of grant, and the tax treatment of those options depend on whether the exercise price is equal to the market value of the shares at grant, triggering a surrender and re-grant can have disastrous consequences for participants and result in tax-efficient status being lost altogether.
Issues usually arise not because discretion exists, but because it is exercised without sufficient regard to HMRC’s guidance. Careful planning when designing schemes, ensuring that discretion is tied to specific circumstances or events, and taking advice if and when discretion is used, are all critical to avoid unforeseen and unwelcome tax consequences for participants.
Vesting, leavers and exits: making the mechanics work together
A common weakness in employee share schemes is failing to properly consider how vesting, leaver and exit provisions interact with one another. Whilst these provisions are usually drafted sensibly when read in isolation, misalignment when they are read together can produce unintended consequences or, in the case of tax-advantaged options, mean they do not meet the qualifying conditions for tax-efficient status. If not correctly drafted, look forward to a large tax bill, often with no realised funds to pay it.
Poorly calibrated leaver provisions can result in departing employees retaining a greater equity interest than anticipated, or open debates around why certain individuals are not “good” leavers. At the same time, overly rigid vesting or exit mechanics can leave little room to deal appropriately with different departure scenarios.
In tax advantaged schemes such as EMI options, the interaction is particularly important. When an employee ceases to meet the working time requirement, their option must be exercised within 90 days to retain tax-advantaged status. In the case of employees who die in service, the EMI legislation provides that personal representatives cannot exercise the option more than 12 months after the date of death. Failure to align leaver provisions with these requirements can inadvertently trigger the loss of tax advantaged status.
Taking time at the outset to consider common scenarios - such as voluntary departures, good leaver events and exit situations - when designing share schemes will ensure that awards or options function fairly, predictably and in line with their original purpose.
Growth shares: ensuring the economics work
Growth shares can be an effective way of allowing participants to share in the future growth in value of their employer where tax-efficient share option schemes cannot be used.
Whilst they are a well-trodden path for employers looking to incentivise key individuals, care must be taken to ensure that they deliver the intended economic return for participants when the shares are sold and the impact on other share classes is fully understood.
As growth shares issued to employees will be ERS, the difference between their market value (or, if a section 431 election is entered into, unrestricted market value) and the amount which the employees are required to pay for their shares, will be treated as income received by the employees when the shares are issued.
The areas to focus on when issuing growth shares are the hurdle at which the shares have any right to value, the “hope” value of the shares at the outset and the drafting of the right in the company’s articles. Undercook the focus on any one of these and you can expect some unwelcome consequences.
First published in Taxation