How do I bring international staff into my share option plan?
Read time: 8 minutes
Veronika Lipinska - Tax Manager, Share Plans & Incentives, BDO UK
A qualified solicitor, Veronika spent her qualifying years in corporate and share plans before moving to BDO. Now she specialises in share plans, working with a broad range of high growth businesses. Veronika implements plans and remuneration arrangements, and creates bespoke tax and non-tax-advantaged plans.
When expanding into new territories – and new tax jurisdictions – tech businesses often turn to company shares and share options as an incentive for new staff members.
As Veronika explains, there are certain things to bear in mind when offering a share option plan abroad. But with the right plan in place, a share option plan can be a wonderful way both to save costs and to lock in and motivate your people.
Why are options a good incentive for employers and employees?
Options are very flexible, and you can tailor them to your business needs. They are usually tied to a particular timeframe, but you can also link them to performance criteria. They can be personal, e.g. linked to employee targets; or they could be corporate, e.g. linked to the business achieving a certain EBITDA target or other growth milestone (or a combination of the two). I’ve seen some tech companies setting a requirement that a patent for a certain piece of IP has to be granted before the options can be exercised, for example.
Options are a good retention and motivational tool. Many start up tech companies have great potential but are cash-constrained. Option plans can allow companies to recruit key staff and incentivize them via shareholder dilution, which can also result in substantial tax efficiencies if correctly structured. The options also offer a psychological benefit, as employees have a sense of ownership and drive towards the business.
You might not be able to pay the most competitive salaries, but you can keep hold of quality people by making them feel a part of your tech business’ future. Most people wish to receive a fair remuneration package for their efforts, so by implementing an option plan which crystallises value on an exit, employees have an incentive to work hard to share in proceeds if the company is sold.
Options can, in certain circumstances, help a company to save costs significantly. With an option, it may be possible to structure it so that the employee won’t get taxed until exit, and the tax rate can be as low as 10%. On an individual level, employees can in some cases save up to 37% of tax. The company can get a corporation tax deduction for the amounts subject to income tax, and potentially save on the NIC liability of 13.8% of the option gain, if the option is taxed in the UK.
What are the key considerations for a tech business considering offering a share option plan?
If you are looking to offer a share option plan, key questions to ask are: Do you roll out the plan that you’ve got in the UK into the other territories, and is that even possible? Or do you have some sort of tax-advantaged arrangement in the other territories, which could mean variants of the scheme between jurisdictions? Do you want to treat the employees the same way across the group or maximize their tax advantage?
You also have to consider the issue of internationally mobile employees. In the tech space, it’s very common to have employees who spend time in different countries or who perform duties for different branches in various jurisdictions. Share option plans are very popular in many jurisdictions, which tends to work internationally.
What plans are available for UK employers?
The most popular plan – one that is often used by high-growth tech companies – is the Enterprise Management Incentive option plan, or EMI for short.
It’s quite generous in that respect, and it’s also very flexible. It gives companies the advantage of offering options to employees instead of shares, with the options being the right to acquire shares in the future.
One key benefit of EMI for the tech entrepreneur is that at the point of making the award, employees don’t automatically acquire voting rights or dividend rights, and they don’t acquire any rights to get any information about the company. So you are able to offer a promise of ownership without any dilution of control until the option is exercised, which may not be until exit. Any growth in value, from the date of grant to the date of sale of shares, is subject to capital gains tax at an advantageous 10% entrepreneurs’ relief tax rate. This is provided the option or shares are held for at least two years, and other conditions are met. By comparison, shareholders hold shares outright and tend to have dividend rights from the get-go, as well as voting rights. They also have certain information rights, such as the rights to access annual accounts, the annual report and more.
The other plan is the Company Share Option Plan, or CSOP. This is a less generous plan than the EMI, in that you can only give people £30,000 worth of shares, and you have to grant market value options. By comparison, with EMI there are no such restrictions, and nd you can choose whether to grant options at market value, or as low as nominal value.
CSOP can be used if the company doesn’t qualify for EMI. It’s also useful as an additional resource for companies that have already used up their EMI allowance.
What happens when an employee leaves?
If you give people shares rather than options, those shares need to be bought back when employees leave a company – and in the tech space, people tend to move around. This is quite an involved process, but if you have a share option plan, the exit is easier to handle. With options, you can make them lapse once employees have left the business. From the company’s point of view, this is great because it saves a lot of admin and resource.
What happens on exit?
What tends to happen is that you make provisions for share-based payments on an exit, and then the holder exercises their options shortly before the sale. So they become shareholders, and they get treated as such. The existing shareholders get diluted, which means they have a smaller proportion of the sale proceeds, but that dilution is of course only temporary.
Upon exit, option holders may get capital treatment, depending on the nature of the option. With the EMI scheme in particular, the company doesn’t get taxed when making the award, and the employee doesn’t get taxed either.
"It is possible to structure the award so there is no tax on the exercise of any options, and when the resulting shares are sold, the tax rate is often a preferential entrepreneurs’ relief tax rate at 10%, as opposed to the standard 20%. So the tax point is exit when the employee is ‘in funds’ to pay the tax."
How can options be offered to an international workforce?
Where possible, the best approach is often to create tailored bespoke solutions for each jurisdiction. But it’s essential that companies think carefully about what solution is most likely to motivate their workforce, and what their expectations are likely to be, given the jurisdiction they work in. In the UK, for example, it’s a fairly standard package to offer salary, bonuses and options, especially in the tech space. In industries such as gaming and software, prospective employees often expect share options as a standard. Some jurisdictions, for example Eastern Europe, tend to prefer cash based incentives, called ‘phantom plans’, which track the value of equity but are not tax advantaged.
Are there cultures where options are a less effective benefit to offer?
Yes. Different countries have different cultures, and there are some jurisdictions where share options are not customary or where employees don’t really trust share options, perhaps because historically there’s a record of options not delivering the promised value. Also, some countries operate regulatory or exchange controls which may hinder acquisition of share options. Areas where option plans are less common include Russia, China and central Eastern Europe.
When is it best to extend a UK-based plan elsewhere, rather than create a new one for another jurisdiction?
You need to ask yourself: what do your employees expect? What’s the in-country culture? Do they expect options like they do in the UK, and can I make them more tax-advantaged? Can I make it tax-advantaged to both the employee and the business?
You also have to consider where the workforce is, and the specific conditions on the ground. For example, Singapore is a big tech hub, but it has a very penal exit tax. So what that means is that employees who leave Singapore may have an immediate tax charge, even though they haven’t crystallised any value. They have to take the money out of their pocket to finance that tax.
There’s also a few quirks around employee mobility. Let’s say you have an employee who works and has options in the UK which are tax-advantaged; if you then send them to set up a US office, there is a chance that there will be double taxation on their options (subject to the double taxation treaty).
In jurisdictions where the option plan isn’t perceived as advantageous, what other kind of rewards might be offered instead?
A typical incentive in this instance would be an annual long term cash bonus under which employees will earn a lump sum. It is a non-tax-advantaged arrangement, but it is very flexible, and is of course a powerful incentive in and of itself.
If a company aims to expand internationally in future, would that alter the way they construct their UK share option plan from the outset?
Not necessarily. The EMI plan, for example, is quite stand-alone. However, you would maybe look to add international schedules to your EMI plan to keep all the plans together.
When setting up plans in new jurisdictions, is it expensive in terms of costs for admin and resource?
There is a set-up cost, depending on the plan. But once you’ve incurred that cost at the beginning, there shouldn’t be much cost going forward throughout the life of the plan. And as we’ve already seen, you are of course saving money in other significant ways over the longer term – in salary, for example.
Are there any key mistakes that tech businesses should be careful to avoid when creating a plan?
One common mistake is to give too much equity away. I have seen some companies where, at a very early stage, they didn’t have money and gave out a lot of share options. The issue then is that, when the company wants to grow, it doesn’t have have enough equity to keep on incentivising employees.
Another common error is giving options without valuing the shares properly. There is often a lack of understanding that the tax value is slightly different to the commercial value. So you could be granting equity to employees at a lower price than for example, the investors have put in.
"We also often see tax advantaged plans which are however not structured or reported to HMRC correctly which means that despite the best intentions, they lose tax advantages."
There’s also the fact that different countries have different valuation methodologies for the same share. For example, the way in which the UK values shares takes into account the illiquidity of the shares and the size of the holding may mean that from a tax perspective, the shares are worth substantially less than a pro-rata value.
However, in Germany or the US for example, there’s a less liberal approach, and they tend to agree lower discounts on the value of the shares. That means that employees have to cash out more in order to acquire the shares; they may also be taxed on the options in a less tax-advantageous way.
Is there a way to offset that issue across territories?
If there are any differences between jurisdictions and the company wants to treat employees evenly, they could equalise them with a bonus, with the company making up the difference in taxes. That’s a common solution.
How should companies communicate with their employees about the plan?
It’s extremely important to communicate the advantages of the plan, the responsibilities of the company under the plan, and the responsibilities of the employee. Employees rightly want to understand what the award means, how much they are getting, and when. They also want to know what happens if they leave the business, and whether the company will do all the reporting for them.
What’s the most common misconception that you’ve come across about how these schemes work?
That it’s got to be complex. I see clients who often start with something really difficult, and they end up with a really simple plan at the end of the day. It doesn’t have to be as complicated as people fear – and in fact, the simpler, the better! If you want to achieve an incentivising effect, it needs to be clear to employees what the benefits are. If the benefits are difficult to explain, then you risk undermining that positive impact.
Want some more advice on how to set up share options? Get in touch by emailing [email protected].