Share incentives in subsidiaries

There may be good reasons why a parent company may want to offer employees shares in a subsidiary.  For example, to provide an incentive which aligns the performance of employees to the growth in value of that subsidiary’s business.

Alternatively, a company may want to sell its subsidiary in the future and wants those employees to be linked to the growth in value of that business, rather than at the parent company level.  This provides a targeted incentive, since employee equity would not be tied to the performance of other parts of the group over which their performance would not influence the ultimate share value.

How

Options are tax inefficient in subsidiaries as the tests for EMI or CSOP would not be met.

However, offering shares gives employees the benefit of immediate share ownership and possibly dividends and can be structured in a tax efficient way   Employees should be subject to capital gains tax (CGT) on the gains realised on sale of their shares, rather than being subject to PAYE/NICs allowing them to benefit tax efficiently from the increase in value of their shares.

There are three share based incentive alternatives that may be appropriate.

Award of ordinary shares:

Employees would either pay for their shares up-front or be taxed on the discount if they acquire their shares for less than the tax market value.  If employees acquire shares at less than market value income tax will be due under PAYE with employer’s and employee’s NICs on the amount of discount.

Pros and cons of share incentives and share options

Share Options are tax inefficient in subsidiaries as the tests for EMI or CSOP would not be met.

However, offering shares gives employees the benefit of immediate share ownership and possibly dividends and can be structured in a tax efficient way.

Employees should be subject to capital gains tax (CGT) on the gains realised on sale of their shares, rather than being subject to PAYE/NICs allowing them to benefit tax efficiently from the increase in value of their shares.

There are 3 share based incentive alternatives that may be appropriate :

Award of ordinary shares

Employees would either pay for their shares up-front or be taxed on the discount if they acquire their shares for less than the tax market value. If employees acquire shares at less than market value income tax will be due under PAYE with employer’s and employee’s NICs on the amount of discount.

What if ordinary shares are too expensive?

Award of growth shares

This should be considered if an equity stake in the subsidiary would be too expensive for the employee to purchase up-front.  A new class of growth shares that should have a low value at the time they are acquired by employees could be created. Growth shares would not share in any value unless an ‘equity hurdle’ is met (e.g. based on the subsidiary’s valuation), and then only in a percentage of value above the equity hurdle.  This means that the employee’s up-front cost to purchase shares should be relatively low.

Award of nil paid shares

Nil paid shares should also allow employees to benefit tax efficiently from the increase in value of their shares above their initial market value.

If offered, the subscription price payable for the shares will be determined by the subsidiary before the date the employee subscribes.  If the price payable for the shares is not less than the tax market value on the acquisition, the employee will not be taxed up-front on any amount.  Instead, the unpaid subscription price will be treated as a ‘notional loan’ on which a Benefit in Kind (BIK) charge (plus employer’s NICs) will be due annually on the outstanding amount until it is paid.  If some or all of the unpaid subscription price is released (or written off), that amount will be taxed under PAYE/NIC).

Other key considerations

Before awarding shares in a subsidiary to employees, there are some important things to consider. For example, should employees be required to sell their shares if they leave employment and should there be any performance conditions?

Further points to consider:

  • terms on which employees’ shares would be subject to sale or transfer, if the subsidiary is sold, and/or if shares are subject to performance conditions, what happens if the conditions are met or not;
  • who would purchase the shares (in the absence of an exit) – would the parent company or the subsidiary buy back the shares?
  • could the employee exchange their shares for shares in the parent company on a ‘value for value’ basis in the future.
  • valuation is key to provide tax certainty for both the company and its employees on the acquisition of any employee shares.  HMRC will not agree tax valuations for shares outside of EMI or CSOP. It is advisable that the subsidiary or parent company obtains a documented valuation from a professional adviser should HMRC challenge at a later date.

Please do speak to us if you have any questions.

Catherine Ramsay

Manages to explain difficult concepts in easy to understand language. In tune with her clients.

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