Equity based compensation in the UK Legal update
Janet Cooper
Head of Employee Incentives
Linklaters & Alliance
What a year!
• Who should pay social security on option gains?
• Will the accounting issues hold us back?
• Government tries to boost employee share ownership in UK
• Overview of developments in Europe
• Changes to the London Stock Exchange
• Impact of e-conomy
National Insurance
• Is there a problem?
1 National Insurance on option gains
What’s the problem?
since April 1999, employer pays NI at 12.2% of option gain
potentially large amount (new economy companies)
uncertainty large and variable provisions in accounts
National Insurance on option gains
What’s the solution?
• pass this cost to employees
• transfer of liability
• recovery of cost
• settle NI liability in advance
National Insurance on option gains
Transfer of NI liability
• effective for US GAAP
• form of joint election must be approved by UK Revenue
• can transfer all or part of liability
National Insurance on option gains
Recovery of NI cost
• not effective for US GAAP
• liability remains with employer
• informal arrangements for employee to refund cost
• no approval necessary
National Insurance on option gains
• Tax deduction for employee
• 47% not 52.2% tax
National Insurance on option gains
Accounting treatment in the UK
• future liability estimated and provided for in accounts
• no provision if election in place
National Insurance on option gains
So what’s to be done …. Ask
• is the company prepared to pick up cost?
• how will it look in accounts?
• do you want to transfer liability?
National Insurance on option gains
To transfer liability
• look at plan rules
• prepare letter and agreement
• get Inland Revenue approval
• speak to accountants
• “cost” of options should be recognised in company accounts
2 Accounting for share-based payments
Accounting for share-based payments
• UK, Australia, Canada, New Zealand and US ASBs
• heard this before?
Accounting for share-based payments
IASBs’ reason for change:
• Company is receiving value of services
• Accounts should reflect cost of this “transaction”
• Not happening under current rules
Accounting for share-based payments
IASBs’ proposals:
• “Fair” value should be charged
• Include existing shares as well as new issue shares
• Includes share-based payments to non-employees
Danger - might make options too “expensive” for some companies
Accounting for share-based payments
What’s “fair” value?
• Calculated using option pricing model (eg Black Scholes)
• Fair value to be determined at vesting
• But:
– options not transferable
– what about unlisted companies?
Accounting for share-based payments
What’s the accounting period?
• Charge to be spread over performance or
vesting period
• Adjustments to be made to reflect
– likelihood of vesting and
– changes in option “value”
Accounting for share-based payments
Financial impact
• double hit to shareholders
• some companies become insolvent overnight
• makes share awards/options very unattractive
• lose edge in “war for talent”?
Accounting for share-based payments
Proposals are wrong
• Options are incentives not salary
• Cost is a dilution cost to shareholders not a profit cost
• Valuation methods arbitrary and unrealistic
Keep very close eye on your ASB!
These proposals are coming your way
Keep very close eye on your ASB!
These proposals are coming your way
Accounting for share based payments
3 Budget 2000 and 2001
Boost for share ownership?
• 2 new qualifying plans for UK employees
• Greater taper relief on capital gains
New qualifying all employee share ownership plan
• Flexible - free, partnership and matching shares (no options)
• To be offered to all UK employees
• Can be related to performance
• But administration burdensome
• Tax benefits if shares held for 5 years
EMI options
• Aimed to help small entrepreneurial companies recruit and retain
• Up to £100,000 options tax free for each of 15 key employees
• No approval procedure
EMI options
BUT company must:
• have gross assets of less than £15m (~$23m)
• be independent
• be trading in the UK
EMI options
Changes announced this November
• remove limit of 15 employees
• increase value limit to £2.5m
CGT taper relief
• Capital gains tax decreases the longer shares are held
• 2000 Budget - taper relief for all employee shareholders
• Effective CGT is 10% on gain if shares held for 4 years!
4 Overview of developments in Europe
• France
• Holland
• Germany
• Italy
• Spain
• Holland• Germany
• France
• Spain • Italy
Country Taxableevent
Maximum socialsecurity payableby employer
Maximum socialsecurity payable byemployee
Top rate ofincome taxpayable
Top rate of capitalgains tax payable
Total
Exercise 20.9% 17.2% 50% 88.1%Austria
Sale within
24 months50%
Exercise 6.5% 1.5% 60% 68%Finland
Sale 28%
Grant 26.6% 7.8% 55.3% 89.7%Norway
Exercise 28%
Exercise 23.75% 11% 40% 74.75%Portugal
Sale 10%
Exercise 12.2% 10% 40% 62.2%UK
Sale 40%
Belgium Grant 16.7% 55% 71.7%
Denmark Exercise 9% 32% 41%
Holland Vesting 18.89% 8% 60% 86.89
Luxembourg Exercise 15.7% 11% 47.15% 73.85
Sale 47.15%
Spain Exercise 32.6% 6.4 48% 87%
Tax on Options - Europe
5 London Stock Exchange
• Demutualised and listed to become London Stock Exchange plc
• To avoid conflict, regulatory work now under Financial Services Authority
• Admission to listing and trading now separate
London Stock Exchange
Merger story
• Talks with Frankfurt Deutsche Börse exchange to form iX-international
• OM Group announces hostile bid
• LSE withdraws from iX talks
• LSE publishes defence to OM bid
• OM bid fails
• What next? Link with NASDAQ?
6 Impact of new e-conomy
• More flexible/shorter vesting
• No performance conditions
• Challenges to corporate governance guidelines
Impact of new e-conomy
War for talent
• Global battleground
• Changing views of institutions?
Impact of new e-conomy
dot.corps
• New incentive design challenges
• Technical challenges
• Institutional investor relations
So, in 2000…..
• Good news - new plans, help on NI costs
• Keep an eye out for future options lobbying
• Bad news - accounting for options
…….. what about 2001?
Thank you