1. David Pett Partner

2.  What is a share option?  A right to buy existing/subscribe for new shares in future at a price fixed at time of grant, and normally subject to conditions such as: ◦ continuing employment ◦ attainment of performance targets ◦ sale of the company/business  The gain on exercise of an employee share option (ie mv of shares acquired, less price paid) is charged to income tax (and, if RCAs, NICs) – whether or not shares can then be sold  Can transfer burden of employer’s NICs (13.8%) on gain on exercise to employee, so effective rate of tax/NICs for higher-rate taxpayer in 2012/13 is likely to be 58.9% 1

3. If the shares are “readily convertible assets” (ie are, or will become, tradeable or the company is not independent):  income tax charges due under PAYE  National Insurance contributions payable ◦ employees’ 2% (above UEL) ◦ employer’s 13.8% 2

4. Employer company can, if independent, claim relief from Corporation Tax for amount of employee share option gain (subject to conditions) 3

5.  CGT on sale of shares  But, IT may be charged if: ◦ shares are “restricted” and employee has not paid the full “unrestricted” value on acquisition ◦ shares are sold for > MV  Entrepreneurs’ Relief (10% rate of CGT) if interest of ≥ 5% held for 12 months  Base cost = price paid + IT charged on acquisition 4

6. 5 £ ‘Pro rata’ value Market value for tax purposes “Exit” Time “Leaver” Any uplift, from a minority interest value to a pro rata value, on exit, should normally be free of income tax/NICs

7. So, what can be done to avoid charges to IT/NICs on future growth in share value without the need for the employee to invest in shares for full unrestricted market value at the outset? ◦ Enterprise Management Incentives ◦ Company Share Option Plans ◦ Share Incentive Plans ◦ Joint Share Ownership Plans 6

8.  Finance Act 2000: First example of legislation produced by an “independent” government-appointed advisory group  Aimed at small, independent, high-growth companies  No prior HMRC-approval required, but option grants must be notified to HMRC Small Company Enterprise Centre within 92 days  Share options, but with commercial flexibility as to the exercise price and when it can be exercised (but must be, if at all, within 10 years and within 1 year after death) 7

9.  Can set exercise price at below MV (even nil!)  Remember need to pay up nominal value of newly- issued shares  If exercise price < MV, the discount is charged to IT at time of exercise 8

10.  No IT/NICs, on exercise of the option, on growth in market value from grant to exercise  If a “disqualifying event” (eg takeover or leaving), relief for accrued gain not lost, and no loss of relief,if option is exercised within 40 days  Note: if “restricted” shares acquired on exercise of EMI option with exercise price = IAMV, then (IUMV – IAMV) falls out of charge  Purpose test: must be for “commercial reasons ….. not …. avoidance of tax” 9

11. 10 MV GrantExercise Option gain exempt from income tax Ex. price £ Time Grant Exercise £ Ex.price Exempt gain Taxable gain Time A “Market value” option: no disqualifying event B “Discounted option” : no disqualifying event

12. 11 Taxable gain Exempt gain Time Grant Disq. Exercise Event GrantDisq. Exercise Event Ex. price MV Taxable gain Exempt gain C “Market rate” option: disqualifying event occurs more than 40 days before exercise D “Nil-cost” option: disqualifying event occurs more than 40 days before exercise £ £ Time

13.  CGT payable on sale of shares  Budget 2012: Entrepreneurs’ Relief (ie reduced 10% rate) available if EMI option shares held by employee for one year (and all other conditions for ER satisfied except the need to hold 5%) ◦ not available if EMI option is “exit only” ◦ lobbying for change 12

14.  Company/group must have < 250 fte employees  EMI company/group must have gross assets of < £30m ◦ sum of gross assets of each group company  EMI company must be independent  Must be no arrangements for loss of independence  Must not carry on a disqualifying activity  One group company must have a ‘permanent establishment’ in the UK 13

15.  All subsidiaries under the ‘control’ of the EMI company must be 51% subsidiaries (and no other person may have control of it)  Any “property managing subsidiary” must be 90% owned  No arrangements must exist which would cause the independence or subsidiaries tests to be failed  Beware: pre-emption rights or investment/funding agreements under which control could be acquired (eg upon conversion of debt securities if bank covenants not met etc) in a “meltdown” situation 14

16.  The activities of the company/group must not consist as to a substantial part (20%) of excluded activities: ◦ dealings in land, commodities, securities (etc) ◦ dealings in goods otherwise than as wholesaler/retailer ◦ banking, insurance, money-lending, debt factoring, financial activities (etc) ◦ leasing or receipt of royalties (subject to exemption for exploitation of self- developed intellectual property) ◦ legal or accounting ◦ property development ◦ farming (etc) ◦ forestry (etc) ◦ shipbuilding or coal and steel producing ◦ operating hotels (etc) ◦ managing nursing homes (etc) ◦ acting as a service company 15

17.  Must be employee of the EMI company or a qualifying subsidiary  Be committed to 25 hours p.w. or 75% of working time  Not have (or be deemed to have) a “material interest” ◦ 30 per cent ◦ applied at grant, not exercise ◦ no “look-back” 12 months ◦ interests of “associates” count, but sibling is not an associate ◦ EMI option shares left out of account ◦ other option shares counted but, if subscription options, ordinary share capital is grossed up ◦ beware existence of EBTs – trust shares disregarded if certain conditions met 16

18.  Overall limit of £3m on aggregate IUMV (at grant) of shares under all EMI options  Individual limit of (now) £120K on IUMV (at grant) of shares under EMI (and CSOP) options to any eligible employee ◦ to be increased to £250,000 “ASAP”  Beware re-grants: the ‘3-year rule’: never grant right up to limit of £[120K] 17

19.  Growth over option period may qualify for CT relief (cf EIS relief)  If shares “restricted”, then any difference between IAMV and IUMV falls out of charge to tax  If employee leaves then, unless he is allowed to keep it/exercise it, it merely lapses  Shareholder dilution occurs only at time of exercise  No concern over minority shareholding interests 18

20.  Must be a written option contract granting an enforceable, albeit conditional, right to acquire shares in a “qualifying company” either:  “long-form” bi-lateral contract or:  rules + “short-form” certificate and agreement to be bound by rules  Grantor can be company or shareholder or EBT (Note: employer may get CT relief whoever grants/provides the shares) 19

21.  HMRC form of notification of grant ◦ includes declaration of eligibility by employee  HMRC annual return on Form 40 20

22. Warning: Remember the 92-day time limit for reporting grant of an EMI option on Form EMI1 Note also the address to which Form EMI1 should now be sent (as from April 2012): Small Company Enterprise Centre HM Revenue & Customs First Floor Fitzroy House Castle Meadow Road Nottingham NG2 1BD 21

23.  “Exit only” ◦ exercisable only upon a sale or change of control (or flotation?) ◦ if employee leaves for any reason, option either lapses or he may retain whole or part but exercise only if Exit occurs within, say, 5 years  No access to reduced 10% ER rate of CGT on sale  “Vesting schedule” ◦ right to exercise accrues over time  “Performance-linked” ◦ option lapses insofar as performance targets not met 22

24.  If option is capable of being exercised before an Exit, then articles of association should be checked to ensure proper provision for: ◦ protecting against disposal to a third party ◦ compulsory offer for sale back for value (good leaver) or nominal value (bad leaver) ◦ permitted transfers to/from an employees’ trust ◦ drag along/tag along  Beware company law problems if articles changed after option granted 23

25. Usual rules of ss1014 – 1024 CTA 2009 apply:  benefit curtailed if option exercised unnecessarily early  no express statutory CT relief for costs of establishing EMI option plan – but relief not excluded by s1038 CTA 2009 (and see Final Regulatory Impact Assessment issued by Inland Revenue in 2000)  ensure set-up costs borne by employer company? 24

26. The treatment of share scheme accounting issues applicable to SMEs will be covered by William Franklin of Pett, Franklin & Co. LLP later in this conference 25

27. William Franklin william.franklin@pettfranklin.com Office:0121 348 7878 Mobile:07889 726 767 Twitter: www.twitter.com/pettfranklin David Pett david.pett@pettfranklin.com Office: 0121 348 7878 Mobile: 07836 657 658 Twitter: www.twitter.com/pettfranklin www.pettfranklin.com 26