Doing Business UK Stock Options 0505 update

1 An important aspect of corporategrowth is attracting employees andmaintaining their loyalty. Stock optiongrants can achieve this goal, butcompanies must be aware of thediverse legal and tax consequencesthat arise when granting such optionsto employees or consultants whowork UK s handling of employee stockoptions does not always imitate that ofthe US. When designing or amending astock option plan to include a UK plan,US companies should consider UKrestrictions and the tax, labor andsecurities law consequences of granting,exercising and selling Options or theirunderlying shares in the Options be granted to UKemployees to purchase a UScompany s Stock ?Yes. It is possible to issue Options toacquire US Stock to a company s (orgroup company s) employees in theUK. However, UK Stock option plans( employee share schemes or schemes ) do not always imitatethose of the types of schemes will beavailable?

2 In the UK, there are approved and unapproved schemes. Approvedschemes require prior approval from theInland Revenue (the UK s version of theIRS). Options granted under approvedschemes are similar to Incentive StockOptions. There are a number of UKapproved schemes. The most frequentlyused in the UK are (i) the companyshare option plan (CSOP) and (ii) thesave-as-you-earn (SAYE) scheme. An unapproved scheme in the UK is anyscheme which is not an approved are the main differences betweenapproved and unapproved schemes?Approved schemes are not very flexiblesince they require pre-approval by, andfrequent reporting to, the Inland can take a few months. Whilethere are tax benefits for employeesunder approved schemes, such schemesalso contain various restrictions whichneed to be satisfied before a scheme isapproved. For example, the option price( the price at which the employeecan purchase the shares) must be themarket value at the date of the grant,the market value of shares over whichoptions can be granted is limited to 30,000 per employee and the exerciseof Options must take place betweenthe third and tenth anniversary of thedate of grant.

3 In general, unapprovedschemes do not have the same taxbenefits as approved schemes, butconsequently they will have fewerrestrictions. However, high growth startup companies (including US parentcompanies) whose gross assets do notexceed 30 million can take advantageof enterprise management schemes(EMIs), which have distinct tax benefitsdespite being unapproved Considerations When a US Company Grants StockOptions in the United KingdomDoingBusinessUnited Kingdom US companiesshould considerUK restrictionsand the tax,labor andsecurities lawconsequencesof granting,exercising andselling Options ortheir underlyingshares in the UK. 2 United Kingdom | Stock OptionsLatham & Watkins | Doing BusinessHow can a US company grant optionsunder a UK scheme?It is generally possible to grant optionsin the UK under an existing US-designedplan with few modifications to thatplan s terms and, for UK purposes, theUS-designed plan will be an unapprovedscheme.

4 The plan itself must still abideby US state and federal securities laws,as well as applicable listing/exchangerules in the case of a publicly-tradedcompany. Depending upon the terms ofthe US plan, it is also often possible toset up an approved scheme in the UKthat is a sub-plan of the US is the tax and social securityregime of UK schemes?Employees need to consider UK incometax, national insurance contributions(NICs) and capital gains tax (CGT)in relation to Options and the sale ofoption shares. Income tax is currentlylevied at the rate of 40 percent for theaverage executive, while a lower paidemployee might be taxed at 22 are similar to US social securitycontributions and may be triggeredby option exercises, as discussed is generally levied at the rateof 40 percent subject to variousexemptions and reliefs, especiallytaper relief, which can lead to aneffective CGT rate of 10 percent forhigher rate tax are the tax implications of anunapproved scheme?

5 Employees are not liable to incometax on the grant of an option (providedthat the option is not capable of beingexercised more than ten years after thedate of grant). There will, however, bean income tax charge at the date ofexercise on the market value of theoption shares at the date of exercise,less the option price ( the purchaseprice plus the cost of grant to theemployee, if any).On a sale of the option shares, anemployee will incur a CGT liabilitycalculated on any subsequent increasein the value of the shares from the dateof exercise until sale. CGT at the rateof 40 percent may be reduced to 10percent if the option shares are held formore than two years before sale. Thereis also a small annual personal CGTexemption. It is possible that an incometax charge will also arise on some ofthe sale proceeds from the optionshares if they are restricted shares(equivalent to restricted Stock ).

6 Provided the exercise price of an EMIoption is the same as the market valueof the shares at the date of grant (whichis normally the case), there is noincome tax charge on the exercise ofthe option. The major advantage of anEMI scheme is that the employee willbenefit from very favorable CGTtreatment on a sale of the option sharesbecause taper relief starts from the dateof grant of the option rather than thedate the employee acquires the shares(as per all other types of option scheme,either approved or unapproved).What are the tax implications of anapproved scheme?For CSOPs and SAYE schemes, there isno income tax on the grant or exerciseof an option. Participants in theseschemes will be subject to CGT uponthe sale of the option shares. Are there any other employment tax orsocial security contribution issues?Both employees and employers mayhave to pay NICs upon the exercise ofoptions under unapproved s NICs are charged at of the gain.

7 employee s NICstend to be much less significant (inmost circumstances, about one percenton this type of gain). NICs are chargedIt is generally possible to grant Options in the UK under an existing US-designedplanwith few modifications to that plan s terms and, for UK purposes, the US-designed planwill be an unapprovedscheme. 3 United Kingdom | Stock OptionsLatham & Watkins | Doing Businesson the fair market value of the shares atthe date of exercise less the amountactually paid for the shares (and thecost of grant of the option itself, if any).The employer and the employee canjointly elect to pass the employer NICcharge onto the employee . This electioncan be a condition of participation inthe scheme and in which case, will beprovided for in the scheme rules. Thereis generally no NIC charge under anEMI, CSOP or SAYE the pay as you earn regime(PAYE), employers are obliged towithhold employee tax and NICs atsource and account for this to theInland Revenue.

8 Employees thereforeare paid a net there any US/UK taxation issues?The US and UK have taken steps toavoid double taxation on gains relatedto Stock option plans. Under a treatysigned by the US and UK, if the grant,exercise or sale is taxable, it isgenerally taxable in the employee scountry of residence. However, thegains may be taxable in the othercountry if services in connection withthe employment were performed treaty assumes that employees willbe able to take advantage of foreigntax credits in their country of residenceas there any consequences ifbeneficiaries move from the UK tothe US or vice versa?A US individual who is resident inthe UK will be liable to tax on incomearising in the UK. However, if a stockoption has been granted to anindividual when resident in the US,the exercise of the option while theindividual is resident in the UK will notgive rise to any UK income tax.

9 Theremay be a charge to CGT on a sale ofthe option shares but this can probablybe avoided provided that the optionshares and any disposal proceeds arekept outside the UK. A US individualwho is not resident in the UK is subjectto tax on income arising in the a Stock option has been grantedto an individual in connection withemployment undertaken in the UK,then the exercise of that option afterthe individual has left the UK andreturned to the US will give rise toincome tax. However, relief may beavailable under the double tax treatyas described above or under US taxlaw if the tax payer is US that the double tax treatyapplies, a US employee seconded tothe UK on a short term assignment islikely to be exempt from UK incometax. If, however, an employee spendsapproximately 183 days or more in theUK during a tax year or if he/she visitsthe UK for periods averaging 91 days ormore in four successive tax years, suchemployee will automatically be treatedas being tax resident in the there any consequences on arestructuring of the US parent company?

10 If the US parent company undergoesany corporate restructuring, then theterms of the Stock option plan may dealwith such an event by re-pricing thestock Options accordingly. The UKscheme will ordinarily mirror theseprovisions. However, if the UK schemeis an approved scheme, there are onlycertain re-pricing provisions which arepermitted to be included in the rulesof the UK scheme for it to receive itsapproved status. The Inland Revenuewill need to approve these rules inadvance for the Options to attract thefavorable tax treatment. If the approvedscheme does not provide for such anevent or re-pricing in the mannerapproved by the Inland Revenue,then the US parent will still be ableto effect its restructuring and re-pricethe Options , but the tax benefits underthe approved scheme relating to anyre-priced shares may be there any works council or dis-crimination issues in the UK?