April 22, 2020
Companies have enormous challenges posed by the Covid-19 pandemic but don’t overlook the impact that this could have on share incentive schemes, both EMI (tax advantaged) and other plans.
Do you have a share incentive plan in place already? Are you concerned that Covid-19 might throw up unexpected hurdles?
Have options already been granted under the plan or are you about to grant more? Could now be the right time to implement a new equity arrangement for your key staff?
Is your existing plan fit for purpose?
EMI Plans: what risks are there emanating from COVID-19?
EMI options are subject to strict conditions: failure to comply can disqualify the employee’s options.
- The working time requirement: employees must be required to spend at least 25 hours per week or, if less, 75% of all their working time on the company’s business. Due to the COVID-19 crisis, employees may have reduced hours or been furloughed under CJRS.Employees who have reduced hours may well continue to qualify, assuming that they meet the 75% of working time element of the requirement.However, if an employee is furloughed, this may technically be a disqualifying event so that the EMI tax advantages could be curtailed (rather than being required to work, the employee is specifically required not to work).However, we understand that HMRC should be publishing guidance on this point soon (and there is hope is that HMRC will publish a concession similar to the one that already exists for employees who are called up to serve as armed forces reservists, i.e. HMRC will treat them as continuing to be an employee of the original employer for the purposes of all tax-advantaged share schemes, including the working time requirement). We will provide an update on HMRC’s approach to this as soon as we are able.
- Notification and reporting requirements: Covid-19 turmoil may cause EMI notification and reporting requirements to be missed. We do not know yet whether HMRC will deem difficulties caused through Covid-19 to be reasonable excuses for late filings. To remind you, though, there are two primary reporting obligations:
- option grants need to be notified to HMRC via the online ERS portal within 92 days of grant; and
- an annual return must be filed online via the ERS portal by 6 July each year (even if no new grants are made in the relevant year).
If you have any questions regarding your EMI filing obligations, then please contact us.
New option grants and falling share prices
Could falling share prices pose an opportunity for share plans?
Are existing options under the water due to high exercise prices?
What is the impact of any enterprise value on performance conditions?
Underwater options: A company might consider the merits of granting new EMI options at the current (new) lower market value and cancelling the old. All ramifications (tax and otherwise) should be considered. For example, EMI shares are eligible for the Entrepreneur’s Relief capital gains tax reduced rate of 10%, provided that 2 years elapses between grant of the option and the date the option shares are sold: granting new options starts the 2-year clock again. If an exit is possible in the medium term, this lost tax break may outweigh the exercise price arbitrage.
EMI plan limits: EMI plans have limits on the value of options that can be granted to an individual or by the company. Drops in the value of the shares may allow further new grants (at the new (lower) market value) within these limits where previously they were prevented. If employees were recently granted non tax-advantaged options, could these, in conjunction with a general health-check of the plan, be surrendered and re-granted in a more tax efficient manner?
Existing performance conditions: are existing performance criteria or conditions attaching to the options or awards still attainable? If not, the relevant options/awards may no longer be incentivising to employees, and you might want to consider granting new options or possibly varying the terms of the options.
Any new grants or amendments to existing EMI options need to be considered very carefully to ensure the tax breaks are retained. There are numerous pitfalls which could cause the option to be disqualified and therefore specific advice should be sought.
General health check in preparation for sale: In any event, this might well be a sensible time to carry out a review of scheme rules more generally. Increasingly, when Wiggin undertake due diligence for a buyer on a company purchase, we discover problems in the target company’s EMI plans, sometimes involving considerable PAYE/NIC bills (e.g. for failure to notify option grants or to meet technical requirements). Now may constitute an ideal time to “health check” existing schemes so steps can be taken now to rectify matters, including granting new options if existing ones are flawed.
Lapse and ‘leaver’ provisions
Could furlough under the CJRS constitute a lapse event for equity awards under existing share incentive plans and could furloughed employees be considered ‘leavers’ under plan rules?
If a plan is drafted flexibly with sufficiently wide board discretions to determine the outcome for furloughed employees with share awards or options, such discretions should be exercised with particular care, in line with the proper processes set out in the plan rules. Clear paper trails demonstrating decision-making processes and consistent treatment of employees is essential.
If plan rules are drafted inflexibly, with limited discretion in-built, we can help to see whether the scheme can be amended to reflect the furlough situation, albeit care is needed tax-advantaged plans are concerned, to avoid disqualifying the plan and/or options granted.
Retention of key employees
Depressed share prices as a result of Covid-19 could be considered an opportunity for employee incentivisation. As mentioned, limits under your tax-advantaged plans might not now restrict such action. Equity incentives may be an ideal alternative to cash bonuses or tool to offset pay-cuts at a time when businesses want to conserve cash.
However, equity incentives should be implemented with care and the full ramifications require thought. For example, assuming share prices recover following the pandemic, some senior individuals could emerge from the crisis in a disproportionately advantageous position. Setting appropriate performance criteria for awards made now will also pose a challenge since it is currently unknown to what extent share prices will recover or how long it will take for businesses to return to their pre-pandemic growth trajectories.
Wiggin is here to help. We will provide further details as and when information from HMRC is issued. In the meantime, please do get in touch with any member of the team if you’d like to discuss any of the above.