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Companies are looking ever more closely at ways of structuring their employee share incentive arrangements to ensure employees receive capital gains tax ("CGT") treatment. With the introduction of the 50% income tax rate from 6 April 2010 and a 0.5% increase in the National Insurance contributions ("NICs") rates from 6 April 2011, the current CGT rate of 18% compares very favourably and the difference in the rates will be at its greatest level for many years.

One arrangement, which has been around for several years but which is now receiving greater attention by both listed and unlisted companies, is the joint share ownership plan ("JSOP"). The JSOP involves the employee jointly acquiring shares with a third party, usually an employee benefit trust ("EBT"), with the employee being entitled to the subsequent growth in value of the shares. The employee must pay for his interest but this up-front payment will often be low and the potential gains can be significant and, most importantly, subject to CGT.

Outline of the plan

The underlying intention of the plan is to enable the employee to receive the growth in value of the company's shares whilst at the same time achieving CGT treatment. The plan is based on the premise that two people can jointly own unequal interests in shares, broadly in the same way that two people can own unequal interests in land. In economic terms the arrangements are similar to a market value option, with the employee receiving just the growth in value of the shares.

In broad terms the plan works as follows:

  • The employee and the EBT jointly acquire shares, either by way of a subscription for new shares or an acquisition of existing shares. The EBT will often hold the legal title to the shares for administrative reasons, but the employee and EBT will both have a beneficial interest in the shares.
  • The employee's interest will entitle him to all, or most, of the future growth in the value of the shares. The plan may impose an annual hurdle increase in the value of the shares (e.g. 5%) which must be achieved before the employee receives any value. The employee's interest may also be forfeited if he leaves or if performance targets are not met. The amount the employee will pay for his interest will usually be small. The EBT's interest is limited to the current value of the shares plus the annual hurdle increase in value, if one has been imposed. Other than any hurdle increase, the EBT is not entitled to any of the growth in value of the shares.
  • At the end of the forfeiture period (if any), or at an agreed time, the employee's rights crystallise and he either receives a fixed number of shares equal to the growth in value of the shares or the shares can be sold and the employee will receive his share of the relevant proceeds of sale.

The plan will normally specify what is to happen in relation to voting rights, dividends and other corporate events (e.g. rights issues or a
takeover) both before and after vesting.

The company will need to fund the EBT to enable it to acquire its interest in the shares, which will normally be by way of a loan. The loan will be repaid by the EBT when the trust can sell its shares, although there is a risk that if the shares fall in value there will be a shortfall. If the EBT and employee subscribe for shares, the arrangement should be cash neutral.

The arrangements can also be structured so that the price the employee is required to pay for his interest is left outstanding until the shares are sold, at which time the acquisition price will be paid, although a few further complications can arise with this approach, including, if the participants include directors, possible loans to directors issues.

Where the arrangements involve a subscription for new shares additional administrative steps may be required including, for example, dealing with the admission of shares for quoted companies or, for unquoted companies, dealing with pre-emption rights.

Tax treatment of the arrangements

One of the most important aspects of the plan is ensuring at the outset that the employee's interest is valued correctly for tax purposes.
Experience with the Revenue has shown that they accept that the value of the employee's interest in the shares at acquisition should be low, as the EBT owns all of the current value of the shares and the employee is only entitled to the growth in value of the shares, usually above a further threshold. However, if the employee pays less than the value of the interest, there will usually be an income tax and NIC charge on the difference. Working with experienced valuers may reduce the risk in this area. Employers may wish to agree the valuation of the interest with the Revenue, although this can only be done once the employee has acquired his interest in the shares.

When the award vests or shares are received or sold, a CGT charge will arise – but currently only at 18%.

As the employee should receive CGT treatment on his gain, his employer will not be able to claim a corporation tax deduction in relation to the arrangements.

Advantages and disadvantages of the arrangements

The main advantages of the arrangements are as follows:

  • The employee should achieve favourable CGT treatment for his gain whilst paying very little upfront for his interest.
  • The plan is very flexible. It can be used by both listed and unlisted companies and can be tailored to specific circumstances, e.g. in relation to leavers provisions, performance conditions, corporate events and annual hurdles. The plan can be used on a one-off or regular basis.
  • No separate class of shares is required so there is no need to change the capital structure of the company before introducing the plan.

The main disadvantages or risks of the plan are:

  • The company will not normally be entitled to a corporation tax deduction in relation to the plan. However, for companies that already have large losses or are not likely to be tax profitable in the near future, this may not matter.
  • Actual shares must be available up-front at the time of the award. If market purchase shares are used, this will have cashflow implications. In either case, companies should think about what would happen if the shares were not ultimately passed to employees, for whatever reason.
  • The up-front valuation of the employee's interest is key and it is very important to get this and certain other aspects of the plan correct for the plan to be successful. If the desired value is not agreed with the Revenue, there could be a large and unexpected up-front income tax charge.
  • The plan is not a Revenue-approved plan and so there is a risk of challenge. However, the Revenue has recently indicated that it would not challenge JSOPs unless they contained unusual features which gave rise to concerns.
  • The plan may be difficult to operate internationally.

Interaction with other arrangements

Many companies already offer Revenue approved arrangements to their employees and where available these should be used in priority to JSOP arrangements. However, as they are subject to strict limits, the JSOP is an attractive way of providing incentives above those limits.

The plan can be implemented on its own or in conjunction with other arrangements. For example it can even be used as a way of providing annual bonuses, with forfeiture being used as a clawback mechanism.

This article originally appeared in Law-Now, CMS Cameron McKenna's Free Online Information Service. To register for Law-Now, simply visit and select the 'Register' link in the main navigation.

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