The Finance Bill suggests favourable changes to the Key Employee Engagement Programme, but let’s KEEP the positive changes coming

Regular readers of this column will know that I have been going on about the Key Employee Engagement Programme (KEEP) for some time now. This is because of its importance to entrepreneurial companies which may not be able to attract appropriate talent given their lack of cash resources when compared with more established competitors. The KEEP allows them to compete by providing share options with favourable tax treatment in the employee’s hands.

As part of his Budget speech this year, Minister Donohoe said that he was extending the KEEP until the end of 2025 and commencing some key 2019 provisions following European Commission approval. The budget documents also noted that certain changes were being brought about for the buyback of KEEP shares. The Minister noted that “Collectively, these steps represent real progress which can be further built upon in 2023”. So maybe more to do? We’ll come back to that in a minute.

The devil in the detail came about at the Committee Stage of the Finance Bill which is making its way through the Oireachtas right now. At the Dail debates on the Bill, the Minister explained the motivation behind the change was “not just the view of the Commission on Taxation and Welfare but also the public consultation we conducted on the operation of the KEEP and a response to issues raised with us, by and large by Irish SMEs.” In short, it’s goods to talk.

The nutshell version behind KEEP is that it’s an exemption from income taxes on any gain realised on the exercise of a qualifying share option under KEEP. Instead, the gain will be subject to Capital Gains Tax (CGT) on a subsequent disposal of the shares. This deferral of the tax until the point of sale when the employee has cash resources to pay the tax liability is the main positive of KEEP.

The Finance Bill gives effect to two measures which had been included in Finance Act 2019 and which had not been commenced while we awaited State-aid clearance from the European Commission. That approval has now been received. These measures allow companies to operate through a group structure to qualify for KEEP, by amending the definitions within the legislation relating to qualifying companies and inserting definitions relating to qualifying holding companies and groups. They also provide for part-time, flexible working for qualifying employees and their movement within group structures. All good stuff, but not new since its original enactment in 2019.

In addition, the Finance Bill further amends “the sunset clause” for the KEEP from the end of 2023 to the end of 2025 which effectively allows a further three years of the relief. The Minister noted that this would “provide certainty to industry as to its longer-term future”. Further, this year’s Finance Bill also doubles, from €3 million to €6 million, the permissible market value of issued but unexercised qualifying share options that companies that qualify for the KEEP can issue. Increasing the cap allows firms to offer larger amounts of share options to more employees, increasing its effectiveness at allowing SMEs to compete with larger companies for workers.

As part of the Dáil debates the Minister noted that the “case has been made that it can be difficult for employees to see the value of share options if they cannot envision selling them in the future. While a company buy-back of shares is generally treated as income rather than capital, capital gains tax treatment as provided for in the KEEP can apply to a buy-back where several conditions are met, including that it is for the benefit of the trade”. This year’s change could mean, where the necessary Ts and Cs are met, a saving of between the potential higher rates for taxes on income and the 33% CGT rate on the gain arising to the respective employee where the company buys back the shares at the required future date. It would be beneficial if the period of ownership terms could be reviewed for such shares.

Why make this change? Buybacks of shares comprise a difficult area in itself and as the Minister said generally bring about income tax. There was a recent decision of the UK Court of Appeal where the judge commenced her judgement with “This is a cautionary tale,…It is impossible not to feel some sympathy for the appellant” and you can guess how that story was going to end. There the taxpayer bought the entire issued share capital of 99 shares from the shareholders for £1.95 million in cash, which he had borrowed, and the company bought back 98 of those shares from him for cash consideration of £1.95 million, leaving him with one share. So £1.95 million in and £1.95 million out but with a £600,000 income tax liability because tax law regarded that buyback as a distribution of profits and income as a result. Therefore, the period of ownership point is of note.

One major challenge for entrepreneurial companies is the various market valuation criteria that must be met and monitored at grant and throughout the life of KEEP. In order to have certainty in relation to these conditions being met then valuations would be required which are typically costly. To reduce these costs guidance on the appropriate valuation methodologies could be issued such that it could be used by these companies that adopt KEEP and that this guidance includes a “safe harbour” approach e.g., that a market valuation would remain in place for a specific period where no material changes in the circumstances of the company. Indeed, clarity as to the operations of the holding company would also be important.

The KEEP has the potential to alleviate many talent issues for entrepreneurial companies such that if the company is successful then employees can share in that extent. The changes brought about in this year’s finance bill are good moves that can be built upon in 2023. Let’s KEEP building!

Please note this article first featured in the Business Post on Sunday 27 November 2022 and was re-published kindly with their permission on our website.