Jsop and sip presentation

Joint share ownership plans and
Share 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

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 Pett
Partner
©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’ !

Sharetrack
Executive Share Plan
Software
Better 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 – Personnel
Records

Sharetrack – Payments
Received

Sharetrack – Share
Purchases

Contact details
David Pett david.pett@pettfranklin.com mobile: 07836 657 658
William Franklin william.franklin@pettfranklin.com mobile: 07889 726767
Stephen Woodhouse stephen.woodhouse@pettfranklin.com mobile: 07836 756031
Office: 0121 348 7878
Twitter: www.twitter.com/pettfranklin
For lots of information, go to our website:

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