United Kingdom: March 2010 U.K. budget - Employee share plan implications

On March 24, 2010, the U.K. government released its 2010 Budget. Among other efforts, the 2010 Budget places an emphasis on tackling tax avoidance, with the Chancellor of the Exchequer, Alistair Darling, planning to raise £500 million annually from proposed anti-avoidance measures.

In line with the overall theme of the 2010 Budget, many of the proposed changes are related to anti-avoidance. The Finance Act 2010, enacted on April 8, 2010, contains some of the measures announced in the 2010 Budget. We have provided below the key measures from the 2010 Budget which will or may affect employee share plans operated in the U.K.

Her Majesty's Revenue & Customs ("HMRC") – Approved Company Share Option Plans ("CSOPs") The adoption of an HMRC-approved CSOP allows employers to grant tax-advantaged share options to their U.K. employees. In particular, the gain arising on the first £30,000 of approved options, measured at the date of grant, will be exempt from income tax and National Insurance contributions.

The Finance Act 2010 will amend the current tax legislation so that approved CSOP options may no longer be granted over shares in a company that is under the control of a company listed on a "recognized" stock exchange (recognized stock exchanges include the London Stock Exchange and the New York Stock Exchange). The effective date of the amendment will be September 24, 2010, however, during a transitional period beginning on March 24, 2010 and ending September 23, 2010, any share option granted under a CSOP will not benefit from the favorable tax treatment if the shares are in a company which is under the control of a listed company.

This change targets 'leveraged CSOP' tax structuring where companies had previously granted approved CSOP options over a special class of shares designed to allow employees to benefit from any growth in the value of a subsidiary of a listed company which would be free from income tax and National Insurance contributions.


Geared growth arrangements

The government has also announced in the 2010 Budget an intention to introduce anti-avoidance legislation designed to counteract attempts by employers to avoid their income tax liability and National Insurance contributions through the use of Employee Benefit Trusts, other trusts and/or third-party intermediaries. However, it remains to be seen how extensive these changes will be.

It has been announced that HMRC will be involved in a consultation procedure to review awards in geared growth arrangements (such as growth shares and joint ownership arrangements). Such arrangements allow employees to acquire securities (or interests in securities) at relatively low cost and pay capital gains tax (currently at 18%) on any gains above a hurdle rather than income tax (potentially at 40% or, from April 6, 2010, at 50%).

The purpose of the consultation will be to ensure that amounts which should be taxed as employment income are subject to income tax and National Insurance contributions. This is likely to impact certain types of growth interests supported by a leveraged participation in the growth in value of the company concerned. The scope of the review remains to be seen, but this may have an impact on private equity structures and other plans for both public and private companies.


HMRC – Approved Share Incentive Plans

With respect to HMRC-approved Share Incentive Plans (SIPs), a company will no longer be able to obtain an upfront corporation tax deduction for stock contributions made to a SIP trust if the contribution is part of a tax avoidance scheme (i.e. if it is not genuinely intended that the shares acquired by the SIP trust would be passed to the company's employees).

In addition, where alterations are made to a company's share capital, or the rights attached to shares which affect the value of the SIP shares, the approved status of the SIP may be withdrawn by HMRC, even if there are no participants in the SIP and/or no shares have been awarded to employees from the trust.

Both of these provisions are set out in the Finance Act 2010 and have immediate effect. While this may not affect many companies, these measures may be regarded as prudent housekeeping by HMRC to prevent future avoidance.


Enterprise Management Incentives

The 2010 Budget also announced proposed changes to Enterprise Management Incentives (EMI) plans which allow employees, under certain circumstances, to benefit from having no income tax and National Insurance contributions liability on the exercise of an option. For a company to qualify for EMI purposes, it must:

- Be a company with gross assets measured at the date of grant of no more than £30 million;
- Employ 250 or less employees (full time or equivalent);
- Be an independent company (cannot be the subsidiary of any other company); and
- Carry on a qualifying trade in the U.K.; trades are generally qualifying trades unless they fall into one of a number of excluded activities.

Currently, companies wishing to offer share options to their employees under EMI plans must operate "wholly or mainly in the U.K.". The 2010 Budget proposes to expand the opportunity to operate an EMI plan so that any eligible company with a 'permanent establishment' in the U.K. may award such approved options. This provision was not included in the Finance Act 2010 and remains a proposal.


Action

- Employers should review any existing CSOP arrangements to ensure that options cannot be granted over shares in a subsidiary of a listed company. Companies have a six month transitional period (starting from March 24, 2010) to amend their plan rules to take account of this change.
- Employers should monitor the consultation process relating to 'geared growth' arrangements (as applicable).
- Qualifying companies with a 'permanent establishment' in the U.K. should consider the possibility of offering share options to employees under an EMI plan.