EQUITY INCENTIVES UPDATE WINTER 2017/2018 - DLA Piper
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EQUITY INCENTIVES UPDATE WINTER 2017/2018
CONTENTS INTRODUCTION
Welcome to issue 2 of our Equity
Incentives Update, dedicated to
2 INTRODUCTION keeping companies informed about
legal and regulatory developments
affecting share-based incentives.
EMPLOYEE BENEFIT TRUSTS
3 AND THE MONEY LAUNDERING
REGULATIONS 2017
In this issue we cover:
■■ employee benefit trusts and new money laundering
regulations;
■■ share schemes and corporate governance, looking
4 SHARE SCHEMES AND at the new Investment Association guidelines
CORPORATE GOVERNANCE and proposals for revisions to the Corporate
Governance Code;
■■ how the availability of entrepreneurs’ relief on
a share sale can be affected by the existence of
ENTREPRENEURS’ RELIEF: WHEN IS
6
different types of share capital: the McQuillan case;
A 5% SHAREHOLDING NOT A 5%
SHAREHOLDING? MCQUILLAN – ■■ a High Court ruling that considered whether a
A CAUTIONARY TALE company could rely on an absolute veto right
contained in its share option agreements;
■■ recent HMRC “spotlights” relating to disguised
EXERCISE OF COMPANY
7 DISCRETION: WATSON V
WATCHFINDER.CO.UK LTD
remuneration arrangements and employee benefit
trusts; and
■■ an update on recent US tax reform as it affects
employee share schemes.
8 ANTI-AVOIDANCE:
NEW SPOTLIGHTS
LYNDA FINAN
Legal Director
T +44 (0)113 369 2439
lynda.finan@dlapiper.com
9 US TAX REFORM AND EMPLOYEE
SHARE SCHEMES
NICK HINTON
Senior Associate
T +44 121 262 5805
nick.hinton@dlapiper.com
DAVID THOMPSON
Partner
T +44 (0)161 235 4182
david.thompson@dlapiper.com
02 | Equity Incentives Update: WINTER 2018
EMPLOYEE BENEFIT TRUSTS AND THE MONEY
LAUNDERING REGULATIONS 2017
The Money Laundering,Terrorist Financing and Transfer ■ will be a taxable relevant trust if, for example, it receives
of Funds (Information on the Payer) Regulations 2017 dividend income from a UK company on shares (in
(“MLR”) impose record-keeping and trust registration practice dividends will often be waived by an EBT), or
requirements on employee benefit trusts (“EBTs”) receives UK source interest on invested funds, or sells an
which are either “relevant trusts” or “taxable asset and is liable to pay UK capital gains tax.
relevant trusts”. A non-UK resident trust will not normally be a relevant
trust (nor therefore a taxable relevant trust) because it will
Relevant trusts
not have UK taxable income or assets: dividends from UK
An EBT is a “relevant trust” if it is: companies will usually be automatically waived, and capital
gains will usually be exempt from UK tax. EBTs will usually
■ UK resident; or
be exempt from the decennial IHT charge, although IHT
■ non-UK resident but has UK source income or assets charges may sometimes be applicable on the distribution
on which it is liable to pay UK taxes. of income or assets and this would therefore need to be
UK taxes for this purpose means income tax, capital gains monitored.
tax, inheritance tax, SDLT, land and buildings transaction tax When does registration have to be completed by?
and SDRT.
Where the registration requirement applies, the deadline
Relevant trusts must comply with certain record-keeping for registration depends on whether the trust is already
obligations and may also be obliged to disclose details of registered for self-assessment (SA) for income tax or capital
(for example) its beneficiaries to law enforcement agencies gains tax.
and third parties (such as solicitors) carrying out money
If already SA registered for income tax or capital gains
laundering checks in relevant circumstances.
tax, registration under the MLR must be completed no
Taxable relevant trusts later than 31 January after the end of the tax year in which
■ Under the MLR, HMRC must maintain a register of the trustees incur a relevant UK tax liability. However,
beneficial owners and potential beneficiaries of “taxable HMRC has announced that for the first year of operation
relevant trusts”. of the new rules, it will not impose a penalty provided
registrations are received by no later than 5 March 2018.
■ An EBT will be a “taxable relevant trust” if the trustees
are liable to pay UK taxes in relation to trust assets or If the trust is not registered for SA and incurs an income
income. tax or capital gains tax liability for the first time in
a given tax year, registration must be completed by
■ A taxable relevant trust is obliged to register through 5 October following the end of that tax year (although, for
HMRC’s online portal and provide certain information the first year, the 5 October 2017 deadline was extended to
through that portal (such as details of trust assets and 5 January 2018).
the identity of beneficiaries).
If the trust is not registered for SA and incurs a
When will an EBT be a relevant trust or a taxable liability to inheritance tax, SDLT, land and buildings
relevant trust? transaction tax or SDRT in the last tax year, it must
A UK resident EBT: register by 5 March 2018.
■ will always be a relevant trust and so must comply with Trustees of EBTs are recommended to take advice
record-keeping obligations; and on their record-keeping and reporting obligations
as penalties will apply for non-compliance.
www.dlapiper.com | 03
SHARE SCHEMES AND CORPORATE
GOVERNANCE
Revised Investment Association Principles of ■■ on dilution, the previous guidelines included a
Remuneration statement that the normal “5% in 10 years” limit could
be exceeded in the case of awards where vesting is
On 3 November the Investment Association (“IA”)
dependent on the achievement of significantly more
published a revised version of its principles of
stretching performance criteria. That relaxation of the
remuneration (“Principles”).
limit has now been removed; and
In a share schemes context, the following are some of
■■ in relation to annual bonuses, details of performance
the key changes:
measures should be clearly disclosed and any
■■ inclusion of a statement that any discretion specific to adjustment to the metrics as set out in the company’s
a particular incentive scheme should be disclosed in accounts should be clearly explained, as should the
the Remuneration Policy as well as in the plan rules; impact of the adjustment on the outcome. Bonus
■■ also in relation to discretion, a statement that targets should be disclosed no later than 12 months
shareholders discourage payment of variable after payment (previously two years). Deferral is
remuneration to executive directors if the business expected of any bonus opportunity greater than 100%
has suffered an exceptional negative event, even if of salary.
some specific targets have been met. In such a case, Reform of the Corporate Governance Code:
shareholders should be consulted; impact on share schemes
■■ as part of the consultation process when amending On 5 December 2017, responding to the BEIS invitation
existing schemes, remuneration committees should in its summary of responses to the Green Paper on
provide details of the whole remuneration structure, Corporate Governance Reform (published in November
not just the proposed changes, so investors have the 2016) the FCA published proposed revisions to the UK
whole picture. Remuneration committees should Corporate Governance Code (“Code”) for consultation.
also review proposals after the consultation process The consultation can be accessed here (https://www.frc.
and prior to finalisation to ensure that the proposals org.uk/news/december-2017/a-sharper-uk-corporate-
remain appropriate in light of any subsequent events; governance-code-to-achieve)
■■ the covering letter sent by the IA to remuneration Key points relevant to share schemes are:
committee chairs notes that a number of companies
■■ in order to improve transparency for shareholders,
have considered changing their remuneration
the Code would be more specific about what action a
structure and moving to restricted shares rather than
company should take in the event of significant votes
LTIPs. The letter notes that the views of members
being cast against a resolution: where more than
differ on the use of restricted shares, and there is
20% of votes have been cast against a resolution, the
concern that new structures are being proposed
company would be required to explain the actions
only when the current structure is not paying out.
it intends to take to consult with shareholders in
The Principles now state that if moving from an LTIP
order to understand the reasons behind the result.
to a restricted share model, the discount rate should
An update should be published within six months of
be a minimum of 50%, the total vesting and post-
the vote, and a final summary should be included in
vesting holding period should be at least five years, and
the annual report or explanatory notes to resolutions
that some members expect restricted share awards to
at the next meeting, on what impact shareholder
be subject to an “appropriate underpin”;
feedback has had on decisions of the board and any
actions or resolutions now proposed.
04 | Equity Incentives Update: WINTER 2018
The FRC consultation asks whether 20% is considered ■■ a provision is proposed that vesting and holding
“significant” and whether an update should be periods for long-term incentives should be at least
published within six months after the vote. five years. The current Code states that shares and
other forms of deferred remuneration should not vest
It is also worth noting that the Investment Association
or be paid in less than three years. A five year vesting
has now launched its pubic register of FTSE companies
and holding period is in any event becoming market
that have experienced dissent at general meetings
practice;
at a level higher than 20 per cent, or withdrawn a
resolution prior to a shareholder vote. A key purpose ■■ a new provision is proposed that remuneration
of the register is to record what companies say they schemes and policies should provide boards with
are doing to address such concerns. The register can be discretion to override formulaic outcomes;
accessed here: https://www.theinvestmentassociation. ■■ there is to be a list of matters which remuneration
org/publicregister.html. 22 per cent of FTSE All-Share
committees should address when determining
companies currently feature on the register, with pay-
remuneration policy and practices, including clarity
related issues top of the list of shareholder concerns.
and simplicity, and alignment of incentives to company
The FRC intends to add a footnote to the Code
purpose, strategy and values. The range of possible
referring to this register.
value of rewards to individual directors should also be
■■ it is proposed that the Code is clearer about when identified and explained at the time that shareholders
a non-executive director is considered to be not are asked to approve the policy. This ties in with the
independent. The current version of the Code lists government’s expressed intention to legislate for
a number of factors to be taken into account by clearer reporting on the range of outcomes from
the board when considering NED independence, complex share-based incentive schemes;
but the revised provision would state that if any of ■■ the description in the company’s annual report of the
the listed factors is present, the NED is considered
work of the remuneration committee should include
NOT independent. One of those factors includes
an explanation of the company’s approach to investing
participation in the company’s share option or a
in, developing and rewarding the workforce, and what
performance-related pay scheme. Linked to this is
engagement with the workforce has taken place to
the proposal to remove the exception which allowed
explain how executive remuneration aligns with wider
non-executive directors to be granted share options
company policy; and
or other performance-related elements if shareholder
approval was sought in advance and shares acquired ■■ new provisions are proposed relating to the
on exercise of options were held at least one year composition and remit of remuneration committees,
after the NED left the board. The new provision including oversight of company remuneration and
states simply that share options and performance- workforce policies and practices.
related awards should not be granted to NEDs;
www.dlapiper.com | 05
ENTREPRENEURS’ RELIEF: WHEN IS A 5%
SHAREHOLDING NOT A 5% SHAREHOLDING?
MCQUILLAN – A CAUTIONARY TALE
In the Autumn of 2017, the Upper Tribunal gave its judgment in the McQuillan case (HMRC v McQuillan [2017]
UKUT 344 (TC)) – a ruling which affirmed HMRC’s view on what constitutes “ordinary share capital” for tax
purposes.
Identifying which shares in a company constitute ordinary carried a fixed nominal right to a dividend, there would have
share capital is crucial in many situations, not least when been no doubt that they were not “ordinary share capital”
considering whether an individual has the requisite and that entrepreneurs’ relief would have been available.
5% shareholding for entrepreneurs’ relief purposes. Perhaps seeking to find what it considered to be the ‘right’
In McQuillan, a married couple owned 66 of the 100 shares answer, the Tribunal decided that there was sufficient
in a company that operated a sandwich shop business. ambiguity in the statutory definition of the term that – for
A minority shareholder loaned the company £30,000 the current purposes only – shares with no right to a
but, as a term of obtaining grant funding, that loan was dividend could be considered to have a right to a dividend at
converted into 30,000 redeemable £1 shares in the a fixed rate (i.e. of 0%).
company. The business grew and, eventually, the 30,000
Whilst this might perhaps seem a fair result, it nevertheless
shares were redeemed and the remaining share capital in
contradicted widely accepted HMRC practice (their
the company was sold. The couple claimed entrepreneurs’
published manuals having been clear for some time that zero
relief in connection with that sale on the basis that, in their
rate preference shares are ordinary share capital). It was
view, they had always owned well in excess of the requisite
therefore perhaps unsurprising to most practitioners that
5% stake in the company’s ordinary share capital.
the Upper Tribunal took a different view to the First-Tier
Nevertheless, HMRC refused their relief request as it Tribunal, dismissing the taxpayers’ case and reconfirming
believed the redeemable shares had to be taken into that HMRC’s interpretation is the correct one. Shares with
account when determining the percentage of the share no dividend rights must always constitute ordinary share
capital that the McQuillans owned. Even though the capital, since a share cannot be said to have a right to a
redeemable shares had little value, the number of those dividend at a fixed rate where it has no right to a dividend
shares in issue was such that the 66 shares the McQuillans at all.
held constituted a very small proportion of the overall share
This is a timely reminder of the importance of considering
capital. The McQuillans disputed HMRC’s position, arguing
all types of ordinary share capital when determining
that the redeemable shares did not constitute “ordinary
whether entrepreneurs’ relief – or other tax advantages
share capital”.
that depend upon ordinary shareholding levels, such as EMI
Legislation defines “ordinary share capital” as “all the treatment for share options – is available. Our experience
company’s issued share capital (however described), other is that individuals often simply disregard preference shares
than capital the holders of which have a right to a dividend (or deferred shares) when determining their proportionate
at a fixed rate but have no other right to share in the equity holdings in their companies. As will be seen from the
company’s profits”. The redeemable shares owned by the McQuillan decision, this is often not the correct approach.
minority shareholder did not carry any right to a dividend Importantly though, the issue is often remediable if spotted
at all. HMRC argued that they must therefore constitute sufficiently in advance of a share sale.
ordinary share capital. However, in the original appeal,
If you have concerns that your entitlement to
the First-Tier Tribunal agreed with the taxpayers. It took
entrepreneurs’ relief may be affected by the nature
the view that the introduction of the redeemable shares
of other share capital in your company, please
was not intended to change anything of substance and had
contact any member of the tax group at DLA Piper
merely been done at the insistence of the agency providing
who can provide assistance.
grant funding. They also noted that, if the shares had simply
06 | Equity Incentives Update: WINTER 2018
EXERCISE OF COMPANY DISCRETION:
WATSON V WATCHFINDER.CO.UK LTD
It is not uncommon for share incentive awards to contain provision affording employing companies the
discretion to determine matters such as the extent to which awards may vest or be capable of exercise.
However, a recent High Court ruling has confirmed previous case law on the extent to which these
discretions will be treated as absolute.
In Watson v Watchfinder.co.uk Ltd [2017/EWHC 1275, a On the evidence, the judge decided that there had been
company had granted share options which could only no real consideration as to whether the company’s
be exercised with the consent of a majority of the discretion should be exercised – it had simply determined
company’s board. That consent was never forthcoming, that the options should not be exercised as the board
but the holders purported to exercise the options in any believed that it had an unconditional right of veto.
event. It could not demonstrate that it had discharged its duty
properly. Accordingly, the court found in favour of the
The court decided that, in the context of the
option holders and allowed their exercise.
Watchfinder awards, the discretion of the board could
not be considered to constitute an absolute veto – this This decision reflects previous case law and is a useful
would essentially render the option meaningless as the reminder that notwithstanding that discretions are
grant of the relevant shares would be entirely within the expressed to be “absolute”, boards must nevertheless
gift of the company. Instead, the court decided that the not reach an irrational or perverse decision.
veto right was merely discretionary – and that there was
an implied duty on the company not to exercise that
discretion unreasonably or arbitrarily.
www.dlapiper.com | 07
ANTI-AVOIDANCE: NEW SPOTLIGHTS During 2017, HMRC published two notable new “Spotlights” – summaries of tax avoidance schemes that they consider do not work. Spotlight 39 refers to arrangements under which users Spotlight 41 relates to HMRC’s victory in the Rangers are told that they can execute documents successfully Football Club case. That case confirmed that, in the re-categorising loans they have received under disguised right circumstances, payments made from an employer remuneration schemes such that they are not treated to a third party (an employee benefit trust (“EBT”) as loans at all (and therefore avoid charges under new in the Rangers case) will be taxed as employment legislation imposing PAYE on any relevant borrowings income when the payment is made to that third party that remain outstanding in April 2019). HMRC have seen (and so irrespective of when/if the relevant employee cases where those loans have been attempted to be re- receives the money). Spotlight 41 details HMRC’s view categorised by the parties such that the relevant monies that this principle applies to a wide range of disguised are said to be held in a ‘fiduciary capacity’ instead. remuneration schemes, no matter what type of third Unsurprisingly, HMRC do not accept that the legal nature party is used. It therefore includes EBTs (even those of the payments can be changed after the event. If the where the funds remain in, or are invested by, the trust), payments were legally loans when originally entered into, employer-funded retirement benefit trusts and a wide loans they remain. Charges under the new disguised range of contractor loan schemes. The spotlight states remuneration provisions can generally therefore only that HMRC will use all of the tools at its disposal in potentially be avoided if the loan is actually repaid by the fighting these types of arrangement, including issuing relevant employees before April 2019. follower and accelerated payment notices. 08 | Equity Incentives Update: WINTER 2018
US TAX REFORM
AND EMPLOYEE SHARE SCHEMES
The US Tax Cuts and Jobs Act (“Act”) became law scrapped its cash bonuses (introduced to take advantage
on 22 December. An earlier draft of the bill caused of the deduction available at the time) in favour of salary
considerable consternation with its proposals for taxing top-ups.
equity compensation (including stock options) on vesting.
New excise tax on executive compensation paid
The final version of the Act does not contain those
by tax-exempt organisations
controversial provisions, but important changes are
made, including: Starting in 2018, the Act imposes a 21 percent excise
tax on “excess” compensation paid by tax-exempt
■■ a loss of tax deductions for public companies in respect
organisations to any of their top five highest-paid
of executive compensation;
executives earning more than $120,000 (as indexed).
■■ introduction of a new excise tax on excess compensation The tax is paid by the employer.
paid to executives of tax-exempt organisations;
New private company equity compensation
■■ the introduction of a new private company equity deferral opportunity
compensation deferral opportunity; and
Starting in 2018, the Act contains a new equity
■■ an increase in the holding period required for carried compensation income tax deferral opportunity for
interest to benefit from capital gains treatment from one non-executive employees of privately held companies,
year to three years. intended to address the problem of having to fund taxes
due on acquisition of illiquid stock. Under this new
In brief:
provision, if an employer establishes a broad-based stock
Loss of public company tax deduction option or restricted stock unit (RSU) grant program for
a year, when eligible employees exercise those options
Under previous rules, public companies could deduct or when the RSUs vest and are settled the employer
up to $1 million in compensation paid in a year to the would have to give the employees notice of the deferral
CEO and next three highest paid executives (excluding opportunity, and the employee would have 30 days to
the CFO), but performance-based compensation derived elect to defer income taxation of the compensation
from awards such as stock options, performance share triggered at that time for up to five years.
units and cash bonus plans, was not counted towards
this deduction limit – so that performance-based Carried interest holding period increased
compensation was fully deductible.
Starting in 2018, carried interests, also known as
Under the Act, starting in 2018, the exception for “profits interests,” issued to funds will need to be held
performance-based compensation and commissions is three years rather than one year to benefit from capital
repealed, meaning that all compensation, even if it is gains treatment.
performance-based, will be subject to the $1 million limit
on deductible compensation. Also, starting in 2018, the For further information about these and other
group of covered executives will include the CFO along compensation provisions in the Act, click here
with the CEO, and the top three executives after the https://www.dlapiper.com/en/uk/insights/
CEO and CFO, and will include individuals who may hold publications/2017/12/tax-reform-brings-changes-
these positions at any time during the year. to-executive-compensation/
Some companies have already begun to change their
remuneration policies in light of the new restriction on
deductibility. It is reported, for example, that Netflix has
www.dlapiper.com | 09
www.dlapiper.com DLA Piper is a global law firm operating through various separate and distinct legal entities. Further details of these entities can be found at www.dlapiper.com. This publication is intended as a general overview and discussion of the subjects dealt with, and does not create a lawyer-client relationship. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. DLA Piper will accept no responsibility for any actions taken or not taken on the basis of this publication. This may qualify as “Lawyer Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. Copyright © 2018 DLA Piper. All rights reserved. | MAR18 | 3208658
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