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Markel Tax

02 Jun 2020

Employee Share Schemes & COVID-19 – An opportunity?

During an economic slump, many companies will be reviewing their compensation and incentive arrangements. Salary increases and bonus payments are likely to be put on hold as profits and cashflow inevitably become strained.

However, during such times of hardship, a company’s equity-based reward plans, particularly the tax-advantaged statutory schemes, can be utilised to greater effect. It is common knowledge, particularly in private companies, that share and share option schemes can be a powerful tool in recruiting, retaining and incentivising management and employees alike.

Paying your employees with somebody else’s money!

In most private companies, employees realise value from their share awards when the company is sold. This means that, ultimately, the purchaser is funding that part of the employees’ remuneration with their own cash.

To preserve cash, private companies may wish to consider an alternative to pay rises and bonuses by offering shares or tax-efficient share options to employees.

Employees often welcome this sort of capital participation in the future of their company, and research has consistently shown that companies with higher levels of employee share ownership have greater employee engagement and productivity.

An opportunity to maximise tax efficiency!

The multiples used to value private companies reflect what is happening in the wider financial markets, which have seen substantial falls since the Covid-19 crisis began. This has a knock-on effect for employee share schemes.

For example, share valuations are usually agreed with HMRC in advance of enterprise management incentive (EMI) options being granted and remain valid for 90 days. 

Where companies have agreed valuations during Q1 2020 and have not yet granted their options, it may be worth approaching HMRC to agree lower values in light of current market conditions. 

If lower market values can be agreed, then there would be more ‘headroom’ in the statutory scheme, meaning that larger individual grants of options can be made, which should mean that there is greater potential for tax-advantaged gains on the eventual exercise of the options and disposal of the shares.

Companies seeking HMRC agreement to EMI valuations in Q2 2020 should naturally be able to secure lower based share values for option grant purposes. Any awards to new joiners or further awards to existing employees should therefore be more appealing to both companies who may be afforded more generous tax reliefs, and employees, who stand to enjoy potential increased gains down the line.

Where higher priced options have already been granted, there is the potential for employees to ‘surrender’ any existing EMI options, in exchange for new EMI options at a lower current market value.

Example – In January 2020 Jane is granted a qualifying EMI option over 25,252 shares, an unrestricted market value of £9.90 per share had been agreed with HMRC – the total value of shares under EMI options is £249,994.80 – just under the EMI individual limit of £250,000. Jane is also granted a non-qualifying option over a further 4,748 shares.

In June 2020 Jane’s employer is able to agree a market value of £7.85 per share, reflecting the fall in the markets.  At that price, Jane’s employer would have been able to grant all of Jane’s options as qualifying EMI options and still fall below the EMI individual limit.

Is furloughing an issue?

There are potentially adverse consequences for companies whose employees have EMI options and have recently been ‘furloughed’ under the government’s Coronavirus Job Retention Scheme. This is because, while an employee has not ceased employment, they may no longer meet the ‘working time’ criteria contained in the EMI legislation. This may then later lead to a ‘disqualifying event’ with unintended, negative tax consequences for an employee.

This does seem rather harsh, and it is hoped that HMRC will treat furloughed employees under a new concession that will enable them to still be treated as eligible employees for EMI purposes. There is a precedent for this sort of concession, as HMRC does allow reservists who are absent from work to be treated as continuing in employment for EMI purposes.

For the moment, the position is not yet clear, and we await guidance from HMRC on this.

Good timing?

One of the criteria for an independent company to qualify to grant EMI options to its employees is that it (or a group) must have no more than £30 million in ‘gross assets’. A silver lining here is that there are companies that may not have previously been eligible to offer EMI options, but during the downturn may now be able to do so as a result of satisfying the gross assets test.

The same can be said of companies who may have been contemplating a transaction which has now terminated. Time spent wisely now on attending to share scheme matters presents a wonderful opportunity to consider and offer new awards to management and employees whilst share values are depressed.

The compliance clock is still ticking

From a share scheme compliance angle, we are now in the three-month period to 6 July 2020 for companies (or their advisers) to file online annual returns for their plans. At the time of writing, there has been no announced relaxation of this deadline and companies are urged to make filings as normal, as automatic penalties can quickly become an expensive headache.

In conclusion, when the economy does improve, companies that have considered and either set up an EMI scheme, or offer further share option awards during their ‘window of opportunity’ in the midst of this pandemic, will be well positioned to reap the future rewards themselves and for their employees.

Our COVID-19 Hub contains a range of information and resources to best support our clients during this difficult time. To receive the latest news and insights by email sign-up here.

Tagged Employment taxes and share scheme COVID-19
Next article in series

01 Jun 2020

Tax considerations before you sell your business