jsop and sip presentation

Joint share ownership plans andShare Incentive Plans

(and why every independent company should now look again at establishing a SIP)

www.pettfranklin.com

One Moorgate Place

Thursday 27 February 2014

Welcome

JSOPs – How do they work?

Stephen Woodhouse

Pett Franklin


27th February 2014

JSOPs summary

• Not share awards; not options

• Employee jointly acquires shares with co-owner (usually a trust)

• Held under terms of JOA

• Proceeds of sale unequal

• Employee receives growth (less carry charge)

• Co-owner receives rest

• Capital gains treatment for employee (like EMI)

• Performance link

©2013 Pett, Franklin & Co. LLP www.pettfranklin.com 3


£

[ 4] % p.a. ‘Carrying’ Cost

SaleAcquisition

Tax point

Employee’s gain

Co-owner’s gain

3 years

‘Threshold

amount’

Carry charge

• Term in JOA which splits proceeds

• Only fair concept

• Percentage and or threshold

• Set by modeling trade off

• Term of JOA –fixed

• Reduces IUMV and potentially accounting fair value


JSOP Benefits

• Growth taxed as capital not income

• Employee pays tax at 28 % not 47 %

• Company saves NICs 13.8 %

• Proven technology

• Tax analysis repeatedly publicly accepted by HMRC and JSOP valuation method accepted

• Flexible

• Same treatment as other shareholders on takeovers


JSOP Issues

• Shares in existence from start (hence carry charge)

• Surplus shares trapped in conventional EBT if performance condition fails (use GPT)

• Close company loans to EBT

• No CT relief on growth

• Upfront cost of participation based on initial market value of employee’s interest (IUMV)

• Need to fix carry charge in advance


History

2002 fully disclosed to HMRC

2002 ERM valuation with HMRC

2006 HMRC confirmation that it is not a disclosable tax avoidance scheme

2006 COP10 ruling confirming tax treatment of JSOP for a specific client

2009 HMRC confirmation to Share Plan Lawyers Group that they accept tax analysis and do not propose to challenge this

2010 Budget: review and consultation on “geared growth” arrangements “to ensure employment income is subject to correct tax and NICs” NEVER HAPPENED


• Early dialogue with HMRC Shares Valuation from which emerged ERM method

• Involves splitting the value of an existing instrument not valuing a new instrument

• New thinking so consulted a leading mathematician


Valuation

Joint ownership paradox

• Challenge to conventional option pricing theory and valuation

• Value of employee’s interest AND co-owner’s interest cannot exceed value of share

• Paradox the more value you attribute to the employee’s interest the less you attribute to the trust’s interest but initially the trust holds all the value

• In the meantime ERM method is as good as anything


ERM

• Developed with HMRC

• Split value of a share to identify value of employees initial unrestricted interest IUMV in share price

• Beta factor and carry charge key but sensitive to all assumptions

• Black Scholes comparison

• Can’t agree in advance

• Best estimate and or PTVC


Valuation Risk factors

Valuation

• Significance of the “carrying cost”

• No ability to agree IUMV in advance of execution of JOA

• Will HMRC Shares & Assets Valuation accept the valuation methodology?

• HMRC not obliged to agree value under “health check” procedure

• Will local inspector re-open question of valuation in response to disclosure under ‘self-assessment’?


Conditions For JSOP

• Can’t use EMI

• Share value meaningful (or not certain that HMRC will agree its not meaningful)

• IUMV sufficiently low for upfront cost to be economically feasible

• Growth prospects; if share price can only fall or flat line not much point as employee gets nothing

• Financial modelling to assess choices


JSOP: Accounting treatment

• IFRS2 charge

• Is it an option: “substance over form”?

• Is it a “cash-settled share-based payment”?

– need for co-owner’s/employee’s options to call for exchange of interests?

• What is the fair value of the interest acquired by the employee?

• Recognise as a “premium-priced option”?

• Experience to date


Documentation

• Design report and financial modeling• Shareholders circular• Plan Rules (to be a scheme)• Trust deed• JOA• S431 election• Participants booklet• Management manual• ERM valuation report


Disclosures

• Form 42

• PDMR disclosures

• Notification to employee of valuation agreement

• Self assessment form


Quoted company JSOPs

• In place of unapproved options/PSPs

• But can be combined with PSPs and matching and deferred share awards so that growth from these awards is delivered as capital

• Convert existing awards sometimes

• Objections -cost of participation too high- convert after a share price dip-insufficient growth expectations-too many Non UK resident senior managers-badly informed Remco

• Build into rules to give future flexibility


Potential Remco concerns

• Is this aggressive tax planning? - No

• Current climate for tax planning and executive compensation

• HMRC attitudes generally

• Balance between loss of CT reliefs and tax savings for employees

• NIC saving for employer but should it take some of tax benefit as well by reducing number of shares that vest

• Uncertainty over tax and accounting treatment of gains in GPT


Why companies should look again at “Share Incentive Plans”

27 February 2014

David PettPartner


©2013 Pett, Franklin & Co. LLP 19www.pettfranklin.com

SIPs – a reminder

• Must have a UK trust for the purpose• “Partnership shares”

– £1,500 (£1,800 from 6 April) per tax year or, if less, 10% of salary– Out of gross salary/bonus– Can have deductions from salary over up to 12 months– Can have 18 month qualifying period (6 months if accumulation

of savings)– Otherwise, all UK resident employees must be invited– No preferential treatment for directors or highest paid– No forfeiture provisions


• “Matching shares”– Up to 2:1 against Partnership Shares purchased– Can be subject to forfeiture at any time– Min 3, max 5 year holding period

• “Free shares”– Up to £3,000 (£3,600 from 6 April) per tax year– Min 3, max 5 year holding period– Can be performance-linked (but messy and complex)– Can be subject to forfeiture at any time

• “Dividend shares”– Reinvestment of cash dividends– Fixed 3-year holding period


Why it’s time to look again at SIPs

• Since 2000

• Low take-up amongst unquoted companies

• Thought to be too complex

• Risk of penal clawback if company sold within 3 years


SIP what has changed ?

• OTS report on tax-advantaged share schemes– Nearly all recommendations accepted

• FA 2013 changes (from July 2013)– Removal of need for a specified retirement age (so no charge to tax on

withdrawal of plan shares upon retirement at any age)– Removal of charge to tax on a withdrawal of shares upon a takeover

(subject to conditions)– Removal of “material interest” (25%) test– Freedom to use restricted shares – but restrictions ignored for

valuation purposes– restrictions on transfer– good/bad leaver provisions– can be non- voting

– Uncertainty re scope for allowing forfeiture on early leaving


Accumulation Period etc

• Preferred by unquoted companies as illiquid

• Problem: exposure to changes in share value

• Payment for “Partnership shares” by monthly deductions from salary over up to 12 months: number of shares acquired can be calculated by reference to M.V. at outset (or at time of acquisition, or lesser of either – but company must specify at outset)

• Removal of limit on reinvestment of dividends on plan shares (although company can specify a cap on the proportion which can be so reinvested)– From 6 April 2013


What if the company is sold ?

• From 17 July 2013

• No tax on a withdrawal and sale of SIP shares pursuant to:– general offer to acquire control – a takeover offer (not defined)– a scheme of arrangement

• In consequence of which the participant receives cash (only) for SIP shares

• Must not be an alternative ‘shares- for – shares’ exchange on offer

• Avoids any risk of clawback if company sold early


Changes in 2014

• self certification/registration from 6 April 2014• increases in limits on tax-free shares

– Free shares £3,000 to £3,600– Partnership shares £1,500 to £1,800– Matching shares ( 2 for 1) £6,000 to £7,200– Dividend reinvestment (already no limit)

• annual returns to HMRC to be made electronically • Partnership shares: may allow obligation to sell on

leaving for at least amount of money used to buy Partnership shares (or MV, if less)

• new rules for enquiries and appeals


Compare SIP award of partnership shares with SAYE options

• SAYE options: the discount (of up to 20%) is a cost to shareholders through dilution;

• SIP partnership shares: the discount (by acquisition out of gross salary) is a cost to HM Treasury !

• SAYE options: must pay bank/building soc. to administer the plan and hold savings under an authorised savings plan;

• SIP partnership shares: savings held by trustee in a normal trustees’ bank account


Compare SIP award of Partnership shares with EMI/CSOP options for all employees

• no CGT on sale after 5 years

• ‘discount’ on acquisition (as bought out of gross pre-tax salary)

• can offer tax-free Matching shares (1 for 10 at least out of NI savings)


Using a SIP in an early-stage/start-up company

• Alternative to SEIS relief ?

• “Founders share plan”

– 4 employee subscribers (being the only employees) each subscribe one share (1p par value) for £1 per share

– company funds SIP trust to subscribe for 4 x 99 shares

– shares gifted as free SIP shares


Advantages of a SIP(as against “growth shares”)

• Standard-form documentation

• Growth in value of “Founders” plan shares is entirely free of tax (exempt from CGT)

– Non-SIP shares probably entirely tax-free because of CGT nil-rate band

• Relative ease of administration

– Can normally be undertaken in-house

• GAAR?


SIPs – the need for a trustee

• Use a guarantee company specially-formed as a wholly-owned subsidiary

• In a small company, use individual directors?

– Risk of unlimited personal liability

– Indemnity from company is only as good as the company itself


Disadvantages of a SIP

• Shares must be offered on a “same terms” basis to all qualifying employees

• Performance-linking of awards of free shares is permitted, but is “messy”


Restricted Shares

• Problem:

– pre-emption of SIP shares of leavers had to apply to all shares of the class forcing an existing non-SIP shareholder employee to sell

• New regime:

– shares can be subject to restrictions which only apply to SIP shareholders


• Up-front CT relief for funding a SIP to acquire a 10% interest

• Of interest to independent companies seeking to establish “employee ownership model” or proprietors seeking a tax-efficient exit

• SIP trust must acquire 10% within a 12 month period

• Shares must be acquired otherwise than “from a company”

• 30% of shares must be awarded as Free, Matching or Partnership Shares within 5 years, and 100% within 10 years. If not, HMRC may withdraw all of the relief by treating amount as taxable receipt when direction given

• Limits, of £1,500 Partnership (with up to £3,000 Matching) and £3,000 Free shares, means that employee profile may not enable sufficient shares to be awarded in time!

• If shares not awarded within 2 years (5, if not RCAs), then SIP trustees subject to CGT on growth in value

Independent companies: using a SIP


• The individual vendor can “roll-over” the gain on sale to a SIP which acquires 10% or more within 12 months if, within 6 months of the SIP trust acquiring 10%, all of the consideration is reinvested in chargeable assets, excluding (only):

– private residence

– EIS shares

– same group company shares

Vendor’s relief for sale to a SIP holding > 10%


SIP Illustration

• Company gifts free shares when company worth £1 million

• Free shares gifted to employees @ 75% discount for minority holding agreed with HMRC

• Company sold or floated more than 5 years later for £10 million


Employee’s Position (Free)

• Gifted £3,000 worth of shares (equivalent to £12,000 before valuation discount) representing 1.2% of share capital

• No Income Tax or NICs on award

• On exit, shares sold for £120,000 (10 x £12,000) completely free of tax


Employee’s Position (Partnership)

• Buys £1,500 worth of shares (equivalent to £6,000 before discount) representing 0.6% of share capital

• For 40% tax payer because of tax and NI actual cost is only £870

• On exit shares sold for £60,000 – Tax Free


No Growth Company

• Shares do not increase in value when company is sold

• On exit shares sold for £6,000 Tax Free

• Effectively a £5,130 tax-free gain (£6,000 -£870) on an £870 investment


Costs of implementation

• documentation

• trust establishment

• share valuation

• ongoing administration/ reporting/ compliance

www.pettfranklin.com©2013 Pett, Franklin & Co. LLP 40

Conclusions

If:

• company is independent

• wishes to allow all employees to benefit from holding shares

the establishment of a Share Incentive Plan is the obvious ‘plan of choice’ !


SharetrackExecutive Share Plan

SoftwareBetter Business - The Employee Ownership Advantage

27 February 2014

Background

⎯ Small private company established January 2000

⎯ Dedicated to developing affordable share plans

software for companies & administrators

⎯ Based at one London location

⎯ Broker & Trustee neutral

⎯ Renowned for quality products & customer service

A number of our clients

use sharetrack and their

feedback

is always extremely

positive.

We enjoy an excellent

relationship and are keen

to continue working with

Cytec

to develop new ways to

improve the participant

experience.

Michael Sleet – JP Morgan

Managing Your SIP

⎯ Outsourced⎯ Function fully outsourced to third party

administrator

⎯ In-house⎯ On excel spread-sheets

⎯ Administration software

⎯ Co-sourced⎯ On excel spread-sheets

⎯ Administration software with transaction

processing assistance from trustee, broker or

third party administrator

Since their appointment

the sharetrack software

has lived

up to expectation fulfilling

our current requirements

and more. We are very

happy with the system, the

level and quality of the

support we have received.

Sue Wells – Travis

Perkins

Sharetrack – Plan Details

Sharetrack – Personnel

Records

Sharetrack – Participants

Sharetrack – Payments

Received

Sharetrack - Contributions

Sharetrack – Share

Purchases

Sharetrack - Reports

SharetrackExecutive Share Plan

Software

Better Business - The Employee Ownership Advantage

27 February 2014

Questions

Reflections and Close

Contact details

David Pett [email protected] mobile: 07836 657 658

William Franklin [email protected] mobile: 07889 726767

Stephen Woodhouse [email protected] mobile: 07836 756031

Office: 0121 348 7878

Twitter: www.twitter.com/pettfranklin

For lots of information, go to our website:



mailto:[email protected]



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jsop and sip presentation

Documents

happened2013 pett

com32013 pett

ptvc2013 pett

value of share paradox

fair value

stephen woodhousepett

hmrcsplit value

emiperformance link2013