Incentive Plan Implementation Guide
March 2015
Incentive Plan Implementation Guide March 2015
Contents
01
02
03
04
Key Stages
Planning and Feasibility
Implementation
Administration
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Incentive Plan Implementation Guide March 2015
Key Stages
Planning & Feasibility
•
•
•
Considerations for
identifying the most
appropriate incentive
arrangement
Performance conditions
and other provisions to
include in the plan
Valuation approach
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Implementation
•
Draft plan rules
•
Employee
communications
•
Valuation – agreed with
HMRC if required
Administration
•
Filing with Companies
House
•
Online registration of
plan
•
Potential PAYE on
exercise or other events
e.g. lifting of restrictions
•
Annual returns
3
Planning and
Feasibility
Incentive Plan Implementation Guide March 2015
Understanding the company's objectives
and constraints
In order to determine which incentive arrangement is most
suitable for your company, you should ask yourselves the
following questions:
• What type of plan does the company wish to operate i.e.. cash plan, share plan, share
option plan or phantom share plan?
• Are there any particular strategic drivers that the company would like to incorporate into
the incentive structures (profit growth, income growth, etc.)?
• Are there any particular personal performance behaviours that the company would like to
encourage?
• Are there any other constraints in relation to the equity structure of the company that may
limit what kind of incentive arrangements could be put in place? For example shareholder
or investor agreements where consents are required?
• Would an 'all employee' plan be supplemented by additional arrangements for sub-groups
of employees (e.g. management)?
• Has a budget been identified to support the new incentive structures or will any new
arrangements have to be self-funding?
• Does the company have any existing share schemes in place? If so, what are they?
• Does the company have an existing employee share ownership trust ("ESOT") in place to
act as market maker for employee-held shares?
• What are the company's strategic goals – for example is an exit event envisaged?
• Is there a time-frame that the company has in mind during which reward arrangements are
to operate and become effective?
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Incentive Plan Implementation Guide March 2015
Share Award vs. Cash Bonus
Companies should consider the pros and cons of using cash or
shares
Cash
Shares
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Key considerations
• Simpler to implement
• No dilution issues
• Short or long-term incentive (not just a bonus!)
• Less tax-efficient for employees
• Costly for the company
• Potential cash flow issues
• Cash can be used to look and feel like shares
Key considerations
• Short or long-term incentive
• Low cost, high return from a commercial perspective
• Aligns the objectives of the company and the
employees
• Better from a cash flow perspective
• Can be more complex to design/implement
• Potential dilution issues
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Incentive Plan Implementation Guide March 2015
Consider whether the company qualifies
for a HMRC Tax-advantaged Share Plan
The advantage of using one or more of the HMRC Taxadvantaged Share Plan arrangements is that they offer wellestablished, tax-efficient arrangements that are easily understood
by both the employee and the company
Depending upon the ownership structure of the company, it may be possible to put in place
an HMRC Tax-advantaged Share Plan (or plans) which would benefit from favourable tax
treatments. If designed and operated correctly, Tax-advantaged Share Plans will result in
little or no income tax charge for the employee, with capital gains tax ("CGT") payable on
the first disposal of the shares.
Tax-advantaged Share Plans have the added benefit of being non-controversial as they are
generally accepted by HMRC, and there is cross-party government support of these as well.
However, it is important to note that the ownership structure of the company may restrict
the ability to implement such approved schemes.
In addition, the shares used for Tax-advantaged Share Plans must be ordinary shares that are
not subject to any special restrictions. This requirement could therefore create a problem for
the company if they wanted to use shares in the company, but did not want to dilute the
shareholdings of the existing shareholders.
The following are examples of Tax-advantaged Share Plans:
•
Share Incentive Plan ("SIP")
•
Save As You Earn Option scheme ("SAYE")
•
Company Share Option Plan ("CSOP")
•
Enterprise Management Incentive Plan ("EMI")
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Incentive Plan Implementation Guide March 2015
HMRC Tax-advantaged Share Plans: EMI
Qualifying Conditions
There are a considerable number of conditions which must be met
in order to qualify for HMRC Tax-advantaged Share Plans
For example, to qualify for an EMI Plan, some of the conditions that would need to be satisfied
are as follows:
Company conditions
• Independence - the company whose shares are being used must not be under the control of
another company nor a 51% subsidiary
• Gross assets - the company or group cannot have gross assets exceeding £30m
• Number of employees - the company or group must have fewer than 250 full time
equivalent employees
• Qualifying trade - the company, or at least one of its subsidiaries must carry out a
qualifying trade on a commercial basis with a view to profit
• Plan limits - the value of all shares subject to EMI options must not exceed £3m
These are just a few of the qualifying conditions for an EMI plan and this list is not
exhaustive.
There are various conditions that an option holder must satisfy in order to participate in an
EMI scheme. At the very least, the option holder must be an employee or director of the
company.
If your company wishes to pursue one of these Tax-advantaged Share Plans, it is important to
thoroughly check that the relevant conditions are satisfied. In the case of an EMI plan, advance
assurance can be obtained from HMRC to ensure the requirements for a 'qualifying company'
are met.
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Incentive Plan Implementation Guide March 2015
Unapproved Share Plans
Unapproved Share Options, in contrast, are more flexible as
they are (relatively) unrestricted by statutory requirements
They can therefore be more readily tailored to include performance conditions to motivate
certain behaviours from the company's employees. The options could also be offered over a
new class of shares, thereby preserving the existing shareholdings (and value) of the current
investors.
However, unapproved option plans do not share the same tax efficiencies as the Taxadvantaged Share Plans. On exercise the difference between the market value of the share
and the exercise price paid will be subject to income tax (at up to 45%) and employee and
employer national insurance contributions ("NICs"). The employer's NIC can be passed to
the employee (who gets tax relief on this additional cost) but this will mean that the
employee pays a high tax and NIC cost of over 50%. Consequently, this approach is not
popular with employees and must be carefully communicated to ensure that it does not
undermine the incentive effect of the award.
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Incentive Plan Implementation Guide March 2015
Other Share Plans
Phantom Share Options do not result in employees receiving shares or a right to receive
shares in the company – ultimately the employee receives a cash payment based on growth in
the value of the company shares. They will therefore leave the current ownership structure
undisturbed.
Phantom plans are very flexible and can be tailored to provide rewards for certain targeted
behaviours, e.g. increased profit or capital growth of the company. However, they are
relatively tax inefficient as awards are taxed as employment income (subject to income tax
and NICs) upon pay-out. Furthermore, they represent a cash cost for the company.
Growth/Flowering Share Plans are useful if the company wishes to incentivise its
employees immediately.
By awarding employees a stake in the business they align their interests with those of the
existing shareholders by offering the opportunity to share in the growth in value of the
company. They are implemented by introducing a new share class which will benefit if the
company grows past a set performance 'hurdle'.
Growth/flowering Shares can also be tax efficient, and if structured correctly, participants
will typically suffer CGT (rather than an income tax liability) if the share rights 'flower' and
the shares are subsequently sold. However, it is important to note that a relatively low
upfront income tax charge would arise on the value of the flowering shares on award.
Because the flowering shares are a new share class, they can be structured so as to not dilute
the value held by existing investors.
However, the incentive effect of flowering shares can be lost if the company fails to grow
fast enough to meet the specified performance hurdle. They are also a relatively complex
arrangement and administratively may not be suitable for a large employee population.
There are also other tax-efficient arrangement which we would be happy to discuss
with you.
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Incentive Plan Implementation Guide March 2015
Provisions of the Plan
Once a suitable incentive arrangement has been decided upon,
the design of the plan can be further considered
•
It may be possible to introduce performance conditions to encourage certain behaviours
from employees, before shares are awarded, shares or options vest, or options can be
exercised. Together, vesting and performance conditions are useful tools to retain and
motivate employees.
•
Careful consideration should be given to the performance conditions and the type of
behaviour which this will encourage.
•
The provisions included within the incentive plan rules should be considered carefully
when designing the plan. For example, a key provision that should be clearly defined is
cessation of employment. Additionally, if there is no exit on the horizon, how the
employees realize the value in their shares can be an issue. In these circumstances, it is
possible to create an internal market with the use of an ESOT. We can help with details
on how this can be designed and implemented.
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Incentive Plan Implementation Guide March 2015
Design Considerations
Plan design aspect
Design considerations
Participants
The company will need to decide which employees within the
workforce will participate.
Quantum of awards
The interaction between achievement of performance criteria and
award amounts must be considered.
Valuation
If shares are used, a transparent and equitable valuation
methodology must also be developed, which is easy for the
company to administer and transparent to the participants.
Good and Bad Leavers
To ensure plans are perceived as having long-term value good leaver
provisions will need to be clear and perceived as being fair to the
participants, as well as meeting the objectives of the company.
Performance Measures
Participant performance objectives and how they will be measured
need to be established. These will be based on the company's long
term objectives and must ensure participant accountability.
Vesting profile
Vesting dates will need to be considered and if shares are issued, the
potential administration burden should be managed.
Funding
Overall funding of the plan, including how participants will realise
value must be considered. If cash will be used, will the company
have the funds to satisfy payments?
Timing
The length of performance and performance periods must be
considered.
If shares are awarded, a pre-determined sale window in which
shares are capable of being sold should also be considered as this
provides certainty to both the company in terms of administration
and the participants.
Realising value
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In the absence of an exit event or existing market for company
shares, the company will need to determine how share value will be
recognised, communicated to and realised by participants.
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Implementation
Incentive Plan Implementation Guide March 2015
Drafting Plan Rules
Typically, plan rules would include details on the following:
•
grant of options / shares
•
plan limits
•
exercise of options / vesting of shares
•
lapse of options / forfeiture of shares
•
consequences of cessation of employment
•
consequences of a corporate transaction
•
employment rights
•
how the plan will be administered
In addition to this, the rules will usually include the following:
•
option or share agreement between the company and the employee
•
grant letter / award letter
•
notice of exercise
If the plan is tax-advantaged, for instance an EMI plan,
an employee declaration should also be included to
confirm that the employee satisfies the relevant employee
conditions.
In addition, there may be other formalities if the plan is
tax-advantaged.
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Incentive Plan Implementation Guide March 2015
Employee Communication
It is especially important that the employees invited to participate
in an incentive arrangement appreciate the value of the award.
Where performance conditions are included they should
understand how they can achieve these. Therefore, employee
communication is key to the success of such an arrangement.
For example, a presentation could be delivered to the employees, outlining how the plan
works and how they could benefit from participating in the plan. Furthermore, a participant
guide could be issued to explain the arrangement in detail.
If there are performance conditions incorporated into the plan, the employees would need to
understand how they can assist the company to work towards achieving the target. In our
experience, it may be helpful to hold a session on the financial performance of the company
alongside the communication of the plan to the employees in order for them to see the clear
commercial strategies and objectives of the company, and how they can assist with this.
We would suggest that the following is included in any employee communication:•
How the plan works
•
Benefits of the plan
•
What the performance conditions are
•
Tax implications of the plan and associated reporting obligations
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Administration
Incentive Plan Implementation Guide March 2015
Administration
The following steps may need to be considered when
implementing a plan:
Revision of
Articles of
Association
•
The Articles of Association should be reviewed to
ensure such a plan can be operated, and the Articles
may need to be revised accordingly.
•
A Board meeting is likely to be required to approve
all documentation and relevant resolutions.
Documents
issued to
participants
•
Final documents must be signed by the company,
participants and where applicable the trust.
•
Tax Election (e.g.. s431) may be entered into for
protective purposes
Filings at
Companies
House
•
Form SH01 would need to be completed and filed at
Companies House.
•
If Articles are amended, a written resolution and the
Articles would need to be filed at Companies House.
Registration of
Plan
•
Share plans would need to be registered online
before the tax year end. This could take up to a week
and therefore should be completed in good time.
•
An annual return would also need to be submitted to
HMRC in relation to the grant or award of shares (and
future exercise) by 6 July following the end of the
relevant tax year.
•
Some or all of the steps above would need to be
undertaken on the issue of new awards to
employees.
•
Share plans may need to be updated to reflect any
changes to the company and its objectives, or the
introduction of new legislation.
•
Share plans typically only last for ten years and may
need to be reviewed.
Board
Resolutions
Annual Returns
New issue of
awards
Updates
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Incentive Plan Implementation Guide March 2015
Registration with HMRC
Any new or existing share plans must be registered online with
HMRC's Employment Related Securities (ERS) service from
April 2014
The company will be able to access the ERS Service through HMRC Online Services –
PAYE Online. Within the ERS service, the company can register the Plan. The company will
need to provide the following details in order to register the Plan:
•
Scheme Type (It is understood that the alternatives are: CSOP, EMI, SAYE, SIP and
Other);
•
Tax Year of First Event;
•
Scheme Name; and
•
Company reference number (CRN) and Corporation Tax reference.
Annual Returns
In addition to this, the company would also need to file an annual return online (formerly
Form 42) for the tax year in which the grants where made and the year the shares were
acquired. This must be submitted by 6 July following the end of the tax year in which the
grant/acquisition/exercise etc. took place.
EMI Plan
HMRC must be notified of the grant of EMI options within 92 days of the date of grant.
This must be done online via the ERS Service online once the plan has been registered.
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Incentive Plan Implementation Guide March 2015
How we can help
Grant Thornton Equity Reward Team
can assist in the design of reward
packages including:
•
designing appropriate performance
targets for incentives
•
identifying innovative approaches for
pay and incentives to ensure that the
company gets the maximum benefit
from the arrangements
•
advising on the design and
implementation of long-term incentives
and bonus arrangements that assist in
achieving the company's business plan
•
drafting disclosure in shareholder
documents and assisting with
communications with shareholders
•
communicating details to participants to
ensure that they are clear on the effect
of any new arrangements.
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As Grant Thornton has a multidisciplinary team we offer a 'one-stop
shop' approach that encompasses these
services and everything necessary to
implement them including:
•
tax, legal and accounting input
•
drafting of all documentation
•
valuation services — including tax,
IFRS valuation and specialist input on
certain types of incentive plans
•
corporate governance advice
•
specialist technical accounting advice
that will assist in your discussions with
your audit team.
Our team comprises solicitors,
accountants, tax qualified staff and
valuation experts who all specialise in
this field.
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Contacts
Incentive Plan Implementation Guide March 2015
Who to contact for further information
We hope that this guide will help you to understand some of the practical, tax and legal
considerations which are relevant when designing and implementing an employee
incentive plan.
Please note that this document is not exhaustive and we recommend that further advice
is obtained when considering your own company's arrangements.
If you require any assistance, please do not hesitate to contact us.
Amanda Flint
Tax Partner, Grant Thornton UK
LLP
T +44 (0)20 7728 3145
E [email protected]
Emma Selway
Tax Manager, Grant Thornton UK
LLP
T +44 (0)207 728 3363
E [email protected]
Sonal Shah
Tax Associate, Grant Thornton UK
LLP
T +44 (0)207 728 2182
E [email protected]
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