It is not always feasible to optimise share incentive awards on a global basis. For awards to key senior management, it is however best to ensure, whenever possible, that any equity reward element is motivating and effective and does not generate an unacceptable pain point in the employer and executive relationship, or worse still a contentious dispute.
Companies headquartered abroad embarking on a commercial expansion into the UK market need to understand the different regimes here across a number of different disciplines. In this article we spotlight some of the most common faux pas that occur and cause risk when an employer seeks to provide an equity incentive to group executives in the UK without properly considering the local treatment of such awards.
Many jurisdictions have country and fact specific tax-favoured share plan arrangements. These can operate very effectively on home turf but do not translate well as an incentive elsewhere.
Free shares – what's not to like?
It may sound like an attractive reward to be provided with shares in your employer group without having to buy these at full value. This can be done on a tax-advantaged basis in the UK under the statutory all-employee Share Incentive Plan. Offers of 'free shares' in other forms are likely to trigger tax and social security liabilities as soon as the recipient acquires a beneficial interest in the shares.
A common misconception of a number of French headquartered companies is that awards of free shares (for example under Les plans d’attribution gratuite d’actions) can be made to UK employees with the same favoured treatment as applies domestically in France.
A US headquartered business might think a nil cost Restricted Stock Unit (RSU) is an attractive award for UK individuals because it has no risk of going 'underwater' compared with a market value share option regarding which the exercise price might, if share values fall, result in no upside opportunity for gain.
Companies headquartered in jurisdictions that generally only tax employment-related shares when the shares are ultimately sold (e.g. Israel) might not be alert to the fact that the UK tax charge can arise much earlier.
French free shares, nil cost RSU and other forms of award under foreign share plans can and do cause headaches for the UK employing entity and the UK participants. Below is a list of some areas of difficulty:
An income tax and social security charge will arise when the beneficial interest is acquired, usually on the vesting date and based on the share valuation at that time. The income tax is due whether or not the shares can be sold. In contrast, an award under a share plan which has been tailored for use in the UK might not trigger such a significant charge.
Timing of the tax charge and lack of liquidity
The treatment above means that tax can be due even when there is no liquidity in the shares or when a close period or lock-up means the shares cannot be sold to release funds to cover the tax charge. In contrast, a share option might sometimes offer more flexibility in relation to the timing of the tax charge i.e. upon exercise of the option by the employee. If the shares subsequently materially fall in value, then there is a risk that by the time the shares are sold, the proceeds received might not be sufficient to cover the tax and employee NIC liabilities. This leaves the executive out of pocket. If the employer provides bridging loan funding to the employee, then this can cause further iterations of tax charge.
Employer payroll withholding
An increasing number of jurisdictions now impose an employer payroll withholding obligation when it comes to collecting income tax due in respect of employment-related security events, but not all do. An assumption that the executive will be personally responsible for reporting and paying the income tax directly as part of their own personal UK tax return filings is often misplaced. Some technical analysis may be required to determine if the UK employer is obliged to operated payroll withholding, but frequently it will be.
Further income tax charge when the shares are sold
If there are restrictions on the shares when the executive acquires them, for example in relation to a post-vest holding period or forfeiture of the shares on cessation of employment, a tax election (under section 431(1) Income Tax (Earnings and Pensions) Act 2003) should be jointly entered into between employer and employee no later than 14 days after the employee acquires the beneficial interest. If such an election is not validly made then a portion of the gain realised when the shares are ultimate sold (or on the lifting of the restrictions if this happens earlier) will be subject to income tax and NICs as earnings income and the sale gain will not all be treated as capital gain. If specific UK tax advice has not been sought, then this important election can be missed.
Internationally mobile employees
Many countries, including the UK, can charge a portion of a share-based payment to tax if the employee has undertaken workdays in that country at any time during the award vesting period. These trailing liabilities can be complex for employers and executives to manage and can lead to double taxation. The pre-departure planning for any senior executive assignee relocating to the UK from overseas should include a review of their equity incentives to determine if there is scope to mitigate tax risk in the destination country. Executives also need to be disciplined in their own tracking of workdays and be alert to the fact that their tax exposure may not be limited to the country in which they resided at the time of the award grant.
Beware the Ides of March
Many overseas companies seem to particularly favour March and December as months for time vesting of share plan awards. March vestings can be particularly challenging for UK employers and UK executives. The UK tax year runs 6 April to the following 5 April, meaning that the March payroll run is the final processing of the year's tax deductions and employers need to ensure that their final submissions are made to HMRC by 19 April.
This leaves little time for ensuring that the correct taxable amounts for March vesting share-based payments are processed correctly via payroll, even where a supplemental payroll run is possible after the normal cut-off date. Furthermore, even if the employer has accounted to HMRC for the tax on time, if the tax has not been indemnified or paid by the employee (either via deduction from pay or via other reimbursement by the employee to the employer) by 4 July following the end of the relevant tax year, there is a risk of a tax on tax charge arising via a penal provision in the UK tax code that applies in such circumstances. That further liability sits with the employee and, once triggered, is not extinguished even when the original tax liability is eventually paid.
Information sharing failures
In multinational groups it is not unusual for local compliance failures to arise due to a lack of information sharing. A UK local finance team may have no knowledge of a share plan grant made to a senior executive under a foreign share plan operated by an overseas parent entity, even though there is a compliance return reporting obligation to disclose that to HMRC. If the parent company has, wrongly, assumed that all reporting and tax payment responsibility rests with the individual executive personally there may be no flow of information to support compliant operation of UK payroll deduction when due.
Whether as a result of an HMRC PAYE inspection, transaction due diligence or otherwise, the discovery of share-based payments tax compliance errors can come at significant cost. This cost manifests not just in terms of financing unexpected liabilities, late payment interest and penalty charges and the time required to undertake disclosure and corrective action, but also in terms of a breakdown in goodwill and trust and confidence between an executive and their employer – a matter which might not be easy to remediate and repair.
How to achieve better outcomes?
Whether an equity offer is made as part of a transaction, hiring process or once an executive is already settled in their role, advice should be sought to ensure that the proposed award can be made compliantly having regard to local securities laws. Where possible, consideration should also be given to crafting the award in a form that will optimise outcomes, including managing tax leakage and timing of tax charge, for employer and participant. Where a high value incentive is to be made to a senior executive, or there is a critical mass of proposed participants, a country specific sub-plan might be the appropriate solution. Implementing a tax-favoured arrangement that, as far as possible, mirrors the commercial terms of the main plan but is adapted to take advantage of available UK tax reliefs locally might ultimately provide a better return. It might also mean less dilution for other shareholders if fewer shares are needed to deliver the target net of tax pay-out.
When a business offers a 'take it or leave it' approach to compensating key senior talent on a 'one size fits all' basis they can sometime live to regret that stance. Executives should have the courage to challenge whether, with a little more expert advice, the form of equity offer might be improved with consequential benefit to both parties.