Share incentives in subsidiaries

There may be good commercial reasons for a parent company to offer employees shares in a subsidiary, for example, to incentivise employees by aligning their interests with the growth and value of the subsidiary's business.

Alternatively, a company may want to sell its subsidiary in the future and link employees to the growth in value of that business rather than the parent company. This provides a targeted incentive, since employee equity would not be tied to the performance of other parts of the group that is outside their influence.

How it works

Options may be tax inefficient when offered over shares in a subsidiary, 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 PAYE and 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.

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 with 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 participate in a percentage of value above that 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 can be sold or transferred, 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 in case HMRC challenges the valuation at a later date.

Please speak to us if you have any questions.