Many US-parented groups offer stock options to their US employees and, where possible, they may offer these as incentive stock options (ISOs). The benefit of ISOs is that, typically, the entire gain is only chargeable to capital gains tax (CGT) on disposal of the shares and there is no income to report on the W-2 form. This makes ISOs a tax efficient form of remuneration, which can aide US companies with incentivisation and retention of key staff.
US-parented groups who wish to expand into the UK typically set up an entity in the UK, recruit initial key employees, and offer them ISOs in the belief that the employees will benefit from the same tax advantages.
But this is not the case. From a UK employment tax perspective, the granting of an ISO to an employee of a UK subsidiary entity typically does not confer any tax advantages. The stock options will automatically be deemed for UK tax purposes to be non-qualifying stock options, and any gain from grant to exercise will be subject to income tax and, likely, social security.
How to make granting stock options more tax efficient
It may be possible to structure the issue of stock options to employees of the UK subsidiary via a tax efficient wrapper, such as a:
- sub enterprise management incentive (EMI) stock option plan, or
- sub company share option plan (CSOP) of the existing US ISO plan.
This should allow the UK individual to benefit from UK CGT treatment on the entire gain, from the grant of the stock options to the disposal of the shares in relation to the exercised option - similar to the operation of an ISO for US employees.
An added advantage of EMI options is that there is no holding period required after exercise in order to secure relief from income tax, unlike an ISO for US employees where the shares must be held for at least twelve months after exercise. The rate of CGT on the disposal of the shares in the UK can be as low as 10 per cent. The issue of stock options under an advantageous plan should also mitigate any social security payable by both the employee and employer, as compared to non-qualifying stock options.
If you’re considering offering UK employees stock options, your HR and tax teams should understand whether a sub EMI or CSOP arrangement can be put in place. These are typically tax efficient for both employers and employees and are a great tool for incentivising and rewarding UK employees. They can also mitigate the requirement to quantify the potential social security payable by the employer at the point of exercise, which can be problematic.