26 May 2023
Equity based awards are common in the US and the UK. Corporates with employees in both the UK and the US, and elsewhere, usually want all employees to be offered the same awards.
The problem is that the legal and tax approaches in the US and UK are very different. The result is that many US companies, who do not check the rules in advance, can end up with some expensive tax liabilities and penalties from HM Revenue and Customs (HMRC).
Here are the top 10 things a US corporate making equity awards to UK employees needs to know.
- If a company makes stock/unit/share awards (which can include phantom awards) to any employee or director, the employer is obliged to register the award or plan with HMRC. This can include situations where an employee or director buys stock or shares for full market value.
- Where stock/unit/share awards (which can include phantom awards) have been made to UK employees or directors, the employer must make an annual tax return to HMRC. This return relates to awards or lapses of awards during the UK tax year (6 April in one year to 5 April in the following year). Failure to make a return gives rise to automatic penalties starting at £100 but potentially up to £5,000 per return.
- Where awards are made subject to vesting conditions, there is usually a tax liability each time the award vests. Where there is monthly vesting, this is quite a burden to keep up with the tax liabilities.
- This liability is often the responsibility of the employer, and they will be required to apply withholding tax (PAYE) for each liability and pay employer’s social security contributions (national insurance contributions) currently at the rate of 13.8% of the value of the benefit. Apprenticeship Levy contributions may also be payable by the company.
- To calculate the tax, the awards need to be valued each time there is an award, or option exercise, or vesting, as the case may be. There is no ‘safe harbour’ concept, so an annual valuation is not sufficient.
- A section 409A valuation is not normally acceptable as an appropriate valuation for UK tax purposes. The UK legislation has special valuation rules. Sometimes the UK valuation that would be acceptable to HMRC will be lower than a section 409A valuation, but sometimes it is higher.
- HMRC will not give pre-approval to valuations unless the award is under one of the statutory tax advantaged plans.
- Unless shares are traded on a major stock exchange, shares and units are usually subject to some restrictions, making them ‘restricted securities’. There is a special, and penal, tax regime for restricted securities. This creates the possibility of regular tax liabilities, such as on each vesting, even though the shares have not been sold, and further employment tax charges on disposal. It is possible to elect to come outside this legislation via a ‘section 431 election’ that must be signed by both the employee and the employer within 14 days of becoming entitled to the stock or share rights, though this can also increase tax charges on acquisition.
- Other rights, including interests in unit trusts, partnerships and contracts for differences, can be taxed in the same way as stock awards. Other events can give rise to taxable amounts/reporting obligations such as the alteration of share/unit rights or those giving rise to an uplift in value.
- There are four UK statutory share plans that give large tax advantages to employees and employers. These are similar to ISOs and ESPPs but can deliver greater value. It is common to add schedules to US employee stock plans to enable UK employees and the employee to gain these tax advantages while receiving broadly the same awards as their US colleagues.
If you are expanding a US Employee Stock Plan into the UK, please contact Fiona Bell or Simon Adams to check your UK tax risks.