The use of tax-advantaged share schemes continues to grow in the UK as these schemes, if operated effectively, could potentially result in significant tax reliefs for employees. In order to qualify for the reliefs, it is imperative that the employer company continuously satisfies HMRC’s on-going compliance requirements whilst the schemes are in operation.
The compliance requirements can be quite detailed and companies sometimes fail to keep up with their obligations. This means that when employees seek to benefit from their participation in the schemes, often on an exit event such as a sale or IPO, due diligence reveals that the tax reliefs may no longer be available to the employees.
We set out some of the key on-going compliance requirements for share schemes that companies must satisfy once they have made awards to their employees.
Registering and notification of options
The employer company is required to register the EMI scheme and notify HMRC of all options granted within 92 days from the date the options are granted. This should be done using HMRC’s online services.
Working time declarations
It is a statutory requirement that all employees declare that they satisfy the EMI legislation’s minimum working time requirement at the time options are granted (the working time declaration). This declaration may be drafted into the Option Agreement (provided it is signed by the employee) or may be a separate document that must be signed and submitted to the company by the employee. It is important to note that an employee must submit a working time declaration every time he or she is granted options by the employer company.
Failure to submit a working time declaration at the time of grant could lead to the options failing to qualify for EMI tax treatment with income tax and national insurance contributions arising at the point of exercise.
Restrictions on Shares
For options to qualify for EMI tax treatment, there is a requirement to notify employees of restrictions attaching to shares over which they have been granted options. HMRC’s view is that referring to the articles of the company in the option documentation may not suffice: the restrictions should be clearly set out and brought to the employees’ attention.
Failing to notify employees of the restrictions attaching to their option shares may lead to the options losing their EMI tax treatment. If the share rights have been updated since the last round of grants, it is important that the company’s EMI scheme documentation is amended to reflect changes to restrictions on the shares.
Whilst it is not a requirement to agree with HMRC on the value of the shares to be used for an EMI, we advise that companies should seek agreement. This should ensure that there is no question as to the exercise value of shares used for an EMI when it comes time for exercise provided that full information was provided to HMRC.
Why is this important? Shares obtained through an EMI scheme will be subject to capital gains tax on the difference between the market value at the time of grant and the market value of the shares on the date of exercise. If the market value of the share at the time of grant was less than the market value on the date of exercise, income tax is charged on this difference. The remaining gain is then subject to capital gains tax.
In most cases, companies granting EMI options are still in the growth phase and are working towards increasing the company’s value for a potential exit. Therefore, at the time employees come to exercise their options, the company’s share value may have significantly increased and if the market value at the date of grant has not been defined, the amount subject to income tax (i.e. the difference in share values at the date of grant and the date of exercise) is at least open to question.
Online annual returns
You must complete an employment related securities online annual return for all the tax-advantaged share schemes run by your company. To do this, you would have to register the scheme by 6 July following the end of the tax year within which the scheme was set up (excluding EMI where there is a 92-day deadline). After completing the first return, you must submit an online return by 6 July each year for every year that the scheme remains active, even if there is no reportable event in that year (in which case you will have to file a nil return).
Failure to properly file your annual returns may incur penalties from HMRC. HMRC will not send you a reminder to file your online annual returns.
Companies should identify who is responsible for monitoring all share schemes currently in operation and keeping track of the number of options or shares held by employees. This includes keeping track of employees who leave, share options that lapse, etc. These internal records will be useful when completing the annual online annual returns and for the purpose of assisting with a due diligence search in the event of a subsequent sale or IPO.