Tax law should step in when share options aren’t optional

Tom Maguire discusses the Key Employee Engagement Programme (KEEP) in his latest Business Post column  

Friday 17 June marked the closing date for the public consultation on the Key Employee Engagement Programme (KEEP). This is a share option scheme and was designed to incentivise Small & Medium-Sized Enterprises to retain and reward staff in a tax efficient manner and to assist them in competing with larger enterprises in the war for talent.

SMEs and scaling entities may not have the resources to compete on a level playing field with larger employers and so rewarding staff with skin in the game means that all sailing aboard those entities’ boats can see their fortunes change with rising tides. They become part of a success story economically should the company concerned succeed.

The nutshell version behind KEEP’s application is that it’s an exemption from income tax, USC and PRSI on any gain realised on the exercise of a qualifying share option under KEEP. Instead, the gain will be subject to Capital Gains Tax on a subsequent disposal of the shares. This deferral of the tax until point of sale when the employee has cash resources to pay the tax liability is the main positive of KEEP. However, take up has been low and hence the need for the “it’s good to talk” public consultation.

When I was chatting with my colleagues Colin Forbes and Sarah Conry in connection with our response to the consultation, we all agreed that KEEP has the potential to become a real selling point for talent for such entrepreneurial companies. Companies that have the potential to be the next “Instagooglefacetweet” may not currently have the resources to attract the right talent. However, when tax law and commercial benefits coalesce then the potential quintuples as a result. So, what to do?

The Ts and Cs behind KEEP are very stringent and therefore need to change. For example, KEEP requires that certain market valuation criteria be met in the context of 1) the share option price, 2) each key employee’s amount of KEEP share rights, and 3) the aggregate amount of share rights that the company may issue under KEEP. One of the most significant practical issues facing SMEs in implementing KEEP is the uncertainty that such valuation conditions have been met i.e., that the share options have been granted at market value, that each employee’s entitlement does not exceed the relevant annual/lifetime limit and that the aggregate issued but unexercised share options do not exceed the €3 million company limit.

The valuation of shares can be a complex exercise especially for non-listed SMEs. Professional valuations (which are not only required on implementation of the KEEP but on an ongoing basis as each new tranche of KEEP shares are granted to employees) place a significant cost burden on smaller enterprises in delivering KEEP share awards to employees. As such this is a significant barrier to these companies implementing KEEP.

In our response to the consultation, we noted that certain countries allow tax authorities to agree a valuation of shares under similar schemes and that approval can be sought in advance of issuing the relevant options. This removes the excessive cost and risk associated with valuing shares giving certainty to the company concerned. Alternatively, guidance on appropriate valuation methodologies to support companies in adopting KEEP could be developed and issued. Such valuation methods should include a ‘safe harbour’ approach on valuing shares in the company.

Right now, certain companies are excluded from participation in KEEP. That places them at a disadvantage in attracting and retaining key staff that are vital to their operations. In particular, this exclusion is likely to exclude certain “FinTech companies” and “InsurTech companies” and should be revisited.

A major challenge for SME companies who wish to operate KEEP for its key employees will be ensuring that the employees have liquidity in relation to their investment in shares. Not all of the companies that introduce KEEP will ultimately be sold to a third party or become listed on a stock exchange. If the company concerned buys those shares back from the individuals concerned, then an income tax charge can arise on the employees which effectively neutralises the benefit of KEEP. Therefore, changes should be made to the relevant legislation to ensure that CGT treatment will apply when a company buys back or redeems KEEP shares.

As an aside, buybacks of shares comprise a difficult area in itself. 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 where that was heading. 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 same day 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.

As I’ve said, many start-up companies are, while in their infancy, only in a position to pay relatively low salaries to employees. KEEP’s linking of the annual award to the employees’ remuneration limits the ability of these companies to attract the key staff needed to grow their business. Therefore, that requirement should be revisited.

On this point, I was chatting with Martina Fitzgerald, CEO of Scale Ireland, and she said that they had made a similar point in their submission. She explained that such a move should allow Irish start-ups to compete for technical and management talent here and abroad and would bring about a simplicity of explanation of compensation structures in attracting talent. You can see her point. As I’ve said many times in this column simplicity eats complexity for breakfast when it comes to attracting investment.

Overall, there are enhancements that can be made to KEEP and Budget 2023 is only around the corner.

Please note this article first featured in the Business Post on Sunday, 26 June 2022 and was re-published kindly with their permission on our website.

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