Incentives, taxes & corporate governance
boardroom
tacks
Summer 2004
contents
Harsh penalties
for failure to report
1
The ever deeper bite
of regulation
3
Cost of options
4
The end of EBTs
5
Corporate Governance Issues
6
New Transfer Pricing rules
6
Flowering shares
7
Testimonials
8
Welcome to the
Summer edition.
There have been many important
changes to the area of employee
incentives and related tax and
corporate governance issues.
Properly designed employee
incentive arrangements remain
critical but it is also vital to have
regard to the latest Government,
Revenue, Accounting and market
Harsh penalties for failure to report
Who ensures that your share plans
are properly reported to the Inland
Revenue? Are procedures in place to
ensure compliance? If not, you
could be building up extremely
severe penalties. The Revenue has
recently announced that it is
tightening up its practice on the
filing of share scheme returns. It has
made it clear that it will impose
penalties on companies that fail to
file their returns on time.
practice. This bulletin highlights
some of the most important
Approved Schemes
changes.
The Share Plan Group is delighted
to announce the promotion of
Jeremy Glover to partner on 7
April 2004.
www.ngj.co.uk
A company with one or more
approved schemes has to file its
annual return within three months of
the date of issue of the return.
Previously, if a company did not file
its return in time, it would receive a
letter or two and maybe a phone
call, from the Revenue reminding it
to do so. The Company Secretary
would collate the relevant data and
submit it to the Revenue, and that
would be that.
The Revenue has said that
henceforth, it will be writing to
companies who have not filed
returns on time advising them that
they have 30 days to file. NO further
warnings will be given!
The implications are:
J An initial penalty of £300 may be
imposed.
boardroom
tacks
J If
the return remains outstanding
after the initial penalty has been
imposed, a further penalty of £60
per day for each day the return is
not filed for each failure to return
can be imposed.
Responsible persons are:
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the employer company;
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any host employer of the
employee in question; this
would apply if an employee
was on secondment;
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persons from whom shares
or options were acquired, eg
trustees of Employee Benefit
Trusts (EBT); and
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persons by whom the
securities were issued.
This could therefore be an
expensive exercise and remember
these penalties will not be tax
deductible!
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Finally, where there are two or
more years’ outstanding returns,
the Revenue may start proceedings
to withdraw scheme approval.
Unapproved Arrangements
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Company Secretaries have to
provide written details to the
reveunue of “reportable events”
such as the grant and exercise of
unapproved options and the
awarding and vesting of restricted
shares on an annual basis.
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The Inland Revenue has just
published a new highly detailed
return form for providing
information in relation to
reportable events.
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This return form should be
completed and sent back by 6 July
in the year following the year in
which the reportable event took
place.
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New legislation has introduced the
concept of "responsible persons".
Previously it was the employer
company's obligation to provide
written details of arrangements to
the Revenue. Now any one of
four responsible persons has to
provide information to the
Revenue.
2
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If written details of the reportable
event are not submitted to the
Inland Revenue by 6 July in the
year following the tax year in
which the reportable event takes
place, each of the responsible
persons may be liable to an initial
penalty of up to £300, followed
by daily penalties of up to £60
per day in respect of each
reportable event.
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Penalty proceedings will be
commenced shortly after 7 July
and no reminders or warning
letters will be issued.
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The implications of this are
potentially enormous. For
example, if a group awards
restricted shares to 20 members
of management using an EBT and
provides written details 28 days
late, the penalty cost could be up
to £79,200!
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The upshot - companies must
have procedures in place to
ensure that they file on time!
Summer 2004
The ever deeper bite of regulation
As this bulletin demonstrates, red
tape and complication is enveloping
share incentives to an ever greater
degree. As we went to press, the
Government announced that
practitioners and, often, companies
will have to register details of all
schemes affecting remuneration by
way of early disclosure when such
schemes are sold. The Finance Bill
contains the enabling legislation, but
the detail will be set out in
regulations and advice on the Inland
Revenue website. First drafts of this
were published in mid May and are
subject to consultation till 30 June.
At a recent meeting wth the Deputy
Chairman of the Inland Revenue,
Dave Hartnett, attended by Michael
Jacobs as Deputy Chairman of the
Share Plan Lawyers Organisation, it
was apparent that this is just the first
stage of a major campaign by H M
Treasury to attack what the
government regards as abusive
practices by some of the largest
accounting firms and others. This
will involve all share incentive
practitioners and their clients. A
great deal of effort will be required
from all to catch the few.
The Share Plan Group is on top of
these proposals, as well as the other
new developments outlined in this
bulletin.
Another major development is the
European Prospectus Directive which
came into force on 1 December
2003. This requires companies to be
based, for the purposes of financial
regulation, in one EU state once and
”The new disclosure rules are
Surgeries
We regularly hold surgeries for
executives and non-executives to
discuss all areas of employee
incentives and share planning. The
feedback shows that this open
surgery format is appreciated by
those seeking to implement such
arrangements.
for all. Thereafter, its filings and
publications will fall to be regulated
by that state. The big trap for
companies is that the first document
published by them on or after that
date which requries regulatory
approval will determine forever the
EU state which has regulatory
oversight of that company. It is
possible that certain documents
relating to share incentives could
qualify for this purpose. Accordingly,
great care should be taken.
If you would like to attend one of
our regular share plan and employee
benefit trust surgeries, please
contact Jeremy Glover on
tel: 020 7360 8113 or
email: jeremy.glover@ngj.co.uk
unprecedently severe.
Advisers will have 5 days to
report and risk £5,000 fines for
errors and failures. The
Treasury risks further
alienating business
Forthcoming events
Michael Jacobs will be speaking on
the taxation of shareholdings and
share incentives at the following
events:
5 July 2004
Marble Arch Marriot, London
“Tax Efficient Private Client Planning”
9 July 2004
The Cafe Royal, London
“Share Schemes and ESOPS”
For more details and preferential
arrangements please contact SarahJane Butcher on 020 7360 6466 or
email: sarah-jane.butcher@ngj.co.uk
with more red tape and
greater regulatory costs”.
Michael Jacobs
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boardroom
tacks
Cost of Options
Share options have historically been
free from an accounting point of
view. If a company granted marketvalue options to employees, the cost
of issuing shares to the employees
when they exercised their options did
not need to be reflected in the
company's published accounts. This
caused considerable disquiet among
certain financial institutions and
accounting standards bodies who
argued that share options are a form
of remuneration and should be
accounted for as such.
The International Accounting
Standards Board has now issued
International Reporting Standard 2
Share-based Payment (IFRS 2) on
accounting for share-based
payments. This includes share
options granted to employees.
The UK's Accounting Standards
Board has just published its standard
(FRS20) which is to apply to
companies for accounting periods
from 1 January 2005 (unlisted
companies for accounting periods
from 1 January 2006).
Options
granted
since 7 November
The
End
of EBTs?
2002 that have not vested before the
effective date of the IFRS will need to
be expensed.
The "cost" will be based on "fair
value" principles determined at the
date of grant. This means that the
value of the option itself will need to
be determined on grant. This will
not be an easy valuation and
companies should be aware of the
need to have this valuation when
Tax Benefits for the Company
Whilst the accounting costs of
granting share options are
increasing, the cash costs of doing so
may decrease for some companies.
After years of effort by the Inland
Revenue and Accounting Standards
Board of trying to ensure a
convergence between the
accounting treatment of share
options and the availability of a
corporate tax deduction for the cost
of share options, recent changes
have meant there is now no
correlation between them.
Most companies can now obtain a
guaranteed corporate tax deduction
in respect of most long term
incentive awards and share option
4
plans. This deduction will normally
only be available when the
employee's award vests or he
exercises his option (as applicable).
However, unlike before, the tax relief
is not dependent on the entries in
the company's published accounts
and will generally be available for the
full benefit received by the
employee.
This statutory corporation tax
deduction has reduced the need for
complicated symmetry arrangements
using EBTs.
they grant options. Quoted
companies may wish to use a
valuation method based on BlackScholes or Binomial theory.
Since the "fair value" is determined
at grant, the final gain made by the
employees will not need to be put
through the company's accounts.
For instance, if an option is granted
over shares and it is determined that
the option is worth £1m at the date
of grant, there will be no need to
reflect a subsequent £5m gain made
by the employee on the exercise of
that option. Therefore, share options
may still be less expensive from an
accounting point of view than cash
rewards.
Summer 2004
The End of EBTs?
Employee Benefit Trusts (“EBTs”)
were formerly used to enable
companies to obtain a corporate
tax deduction for the cost of
issuing shares to employees.
Corporation tax relief is now
available on a statutory basis
although generally delayed until the
employee is liable to income tax
and National Insurance
Contributions on the benefit
received by him.
EBTs have also been used as a
means of providing an early exit for
shareholders in an unquoted
company. The EBT, usually funded
by the company, would acquire
shares from shareholders and use
those shares for the purposes of
employee incentives. The
shareholder would receive cash for
his shares and hopefully the benefit
of business asset taper relief on any
gain made. Care needs to be taken
in such situations since the Revenue
is challenging some such
arrangements.
J
J
J
From 1 December 2003, public
companies listed or traded on
the London Stock Exchange, the
Alternative Investment Market
or elsewhere in the European
Economic Area have been
allowed to hold up to 10 per
cent of their issued shares in
treasury. Treasury shares are the
company's own shares that the
company has acquired and kept
for use in the future. These
shares are available for use in
employee share arrangements.
of treasury shares as if this was
the issue of new shares.
J
The restrictions in the Listing
Rules on the timing of share
transfers to employees are more
onerous in respect of treasury
shares than in respect of
independent EBTs.
a company will save trustee
fees; and
avoid the 0.5 per cent duty
payable on the transfer of
shares by an EBT to an
employee since transfers of
treasury shares are exempt from
stamp duty.
So why would you still
use an EBT?
Treasury shares will not replace EBTs
in all (or probably most) cases.
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Introduction of Treasury
Shares
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In the spirit of simplifying
employee share arrangements
and avoiding the use of offshore
trusts, the Government hopes
that companies will use treasury
shares to satisfy awards under
employee share schemes instead
of using EBTs. There are
certainly advantages in using
Treasury shares, for instance:
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The Share Incentive Plan can
only be operated using an EBT.
Schedule 2 to the Income Tax
(Earnings and Pensions) Act
2003 provides that shares used
in a Share Incentive Plan, must
be held by a trustee.
Companies that are concerned
about dilution limits contained
in institutional shareholder
guidelines will still consider
using EBTs. EBTs can be used to
circumvent standard dilution
limits. It had been hoped that
treasury shares would be treated
in the same way. Unfortunately,
it appears that institutional
sheholders will treat the transfer
“Complex scheme
administration and
presentation of the
independence of the
operators of the scheme
may mean that companies
may still prefer to appoint
independent trustees”.
Jeremy Glover
5
boardroom
tacks
Corporate Governance Issues
New ABI Guidelines on Executive
Remuneration were published in
December 2003. Notable Points in
the new guidelines include:
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Treasury Shares
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As mentioned on page 5,
treasury shares will count
towards the overall scheme
dilution limit of 10 per cent in
any 10 year period.
Remuneration Policy
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Performance related
arrangements should be regularly
reviewed to ensure that they are
in line with current best practice.
Remuneration Committees must
be able to satisfy shareholders
that the company is not paying
above the market rate to attract
and retain the directors needed
to run the company successfully.
pension entitlements on account
of variations to contracts
following changes to the taxation
of pensions.
Takeovers and mergers
J
J
The ABI has underlined its strong
opposition to retesting of
performance conditions for all
share based incentive schemes.
In deciding what awards should
vest on a change of control, the
financial performance of the
company subject to the change
of control, should be a key
factor.
Forthcoming Pensions
Legislation
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Shareholders do not expect
directors to be paid
compensation in relation to their
New transfer pricing rules
Traditionally, the transfer pricing
rules have not generally applied to
UK groups of companies. The aim
of the transfer pricing rules has
been to stop profits that would be
subject to corporation tax rates
here from being sent off to another
group company resident in a low
tax jurisdiction.
The Finance Bill 2004 now extends
the transfer pricing legislation to
transactions between two UK
resident companies in a UK or an
overseas group. This means that,
in the future, non-arm's length
transactions between, say, a UK
parent and a subsidiary may be
reviewed for corporation tax
purposes on arm's length terms.
6
What has this got to do with
employee share schemes?
The Revenue recently won a tax case
in which they argued that a UK parent
of an overseas subsidiary was
providing business facilities to the
overseas subsidiary by letting its
employees participate in the parent’s
employee share scheme.
have picked up the “cost” since it
benefited from incentivised employees.
The “cost” which is considered by the
Revenue to be based on the supposed
cost of the employer to hedge up front
the future cost of the incentives, should
have been paid by the overseas
subsidiary to the UK parent.
A full recharge of, say, the option
spread cost would not be acceptable.
The Revenue won its argument that,
for corporation tax purposes, the UK
parent's profits should be increased by
the "cost" of allowing the subsidiary's
employees to participate.
Companies that offer participation to
employees of subsidiaries may, in the
future, find that their profits are
artificially increased for corporation tax
purposes.
The reasoning the court gave was that
the arrangement was not at arm's
length. The overseas subsidiary should
Balancing payments may subsequently
be made to reflect the tax
reclassification.
Summer 2004
Flowering shares
One issue of interest which has
emerged from the new legislation is
how it applies to "flowering shares".
Flowering shares are shares whose
rights may increase over time, usually
contingent on performance targets
being satisfied. For example, a
company may award its managers'
shares which have no voting rights or
rights to dividends at the outset.
When the manager meets his target,
the shares will flower and those
rights will come into fruition.
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The Inland Revenue has indicated
that it would not seek to impose
a double tax charge under the
restricted securities regime and
the convertible securities regime
and that the payer may choose
which provision he is taxed under.
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The "benefit" of falling within the
restricted securities regime is that
it is possible for the employee and
the employer to elect out of it
and thereby avoid future income
tax charges and National
Insurance contributions (NIC) on
gains on the shares. The potential
and uncertain NIC charge on the
employer on future gains will
make it attractive for an employer
to elect with the employee
upfront that the shares be treated
as unrestricted.
Do “flowering shares” work?
J
The Inland Revenue has said it
may take the view that flowering
shares are convertible securities.
This means an income tax charge
would arise when the shares
become full ordinary shares.
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In any event, flowering shares will
probably constitute restricted
securities under the new
legislation.
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If both of these steps are taken,
future gains on the shares could
arguably be subject to capital
gains tax (CGT) instead. Taper
relief on business assets for CGT
purposes could then substantially
reduce the rate of CGT on a sale
of the shares provided they are
held for two years.
J
This area is extremely complicated
and depends on the particular
circumstances. However, the
Revenue may seek to apply
income tax under other antiavoidance legislation. It is
therefore not recommended for
companies to implement new
flowering share arrangements.
Companies with existing flowering
share arrangements should
seekprofessional advice as soon as
possible.
The employee will need to pay
unrestricted market value (ie what
the shares would be worth on
conversion) for the shares upfront.
7
boardroom
tacks
Jeremy Glover
Testimonials from the latest directories
Jeremy joined the firm in May 2003
after heading up the Entrepreneurial
Group at Ernst & Young LLP.
Chambers and Partners
2003-4 Edition
Legal 500
2003 Edition
Employee Share Schemes
The team is known as a share
scheme advisor to smaller
companies, in sectors that typically
include property, sport and leisure.
The Lawyers: Michael Jacobs, who
has been involved in the area since
1987, brings his background in
corporate and tax law to bear in his
dedicated employee share schemes
practice. Competitors see him as a
"bright and likeable" individual who
"knows his law".
Employee Share Schemes
Michael Jacobs at Nicholson Graham
& Jones is another big name in the
market. He is also head of the firm's
private client department and as
such tends to advise medium-sized
companies, particularly in the build
up to flotation.
Trained as a solicitor at a leading City
law firm, he spent several years with
PriceWaterhouseCoopers before
joining Ernst & Young. His
experience ranges from incentives for
start-ups and development capital
companies to IPOs and international
schemes. He is a member of the
Share Schemes Committee of the
Quoted Companies Alliance and
contributed to their new publication
“Rewarding Success”.
Jeremy is a well known speaker on
share incentives and is happy to talk
to chairpersons, chief executive
and/or their executive teams on what
would be best for their company.
The firm is also recommended for its
share incentive schemes.
Head of department Michael Jacobs
was pointed out to researchers as
"particularly good at dealing with
entrepreneurs and their problems."
Recent Work
J
Arlington Securities Limited
context of a major open offer
and placing.
Advising management on their
management buy-in.
J
J
Eurodis Electron plc
Advising the company on its
employee incentives in the
Who to contact
For further information contact
Jeremy Glover, Michael Jacobs or
Samantha Lenox.
jeremy.glover@ngj.co.uk
michael.jacobs@ngj.co.uk
samantha.lenox@ngj.co.uk
© Nicholson Graham & Jones 2004
8
Galahad Capital plc
Advising the company on its
reverse takeover of Shambhala
Gold Limited
Nicholson Graham & Jones
110 Cannon Street, London EC4N 6AR
020 7648 9000
Internationally a member of GlobaLex
The contents of these notes have been
gathered from various sources. You
should take advice before acting on any
material covered in boardroom tacks.
J
Major internet company
Advising the company on its
merger with a large US NASDAQ
quoted company