In this week’s article, we analyse the Key Employee Engagement Programme also known as the “KEEP scheme.”
Historically, gains on exercise of share options would have been subject to income tax for employees at the date of exercise. Given our high marginal income tax rates, the ability to incentivise staff through share schemes had been criticised as being too penal from a tax perspective. It also created a tax charge for the employee at a time when no monetary gain had actually been realised.
Hence, the KEEP scheme was a welcome introduction in Finance Act 2017, as it provided that any gain obtained on the exercise of a qualifying share option granted on or after 1 January 2018 and before 1 January 2024 would be exempt from income tax, USC and PRSI.
This gain shall not be reckoned in computing income for the purposes of the Income Tax Acts. Instead, the full gain arising on the sale of shares, acquired from the exercise of options under the KEEP scheme, would be liable to CGT on disposal.
This allowed for the deferral of a tax charge until the gain was fully realised and also a potential tax differential of 16% or 19% on the gain at date of exercise; depending on the employee’s marginal rate of tax, compared to the treatment of standard share option gains.
In order to qualify for the KEEP, an option must be exercised within 10 years of grant. Therefore, the latest date on which a KEEP option could potentially be exercised at present is 31 December 2033, assuming the option was granted on the current latest possible date of 31 December 2023.
Share options granted on or after 1 January 2024 will not qualify for this tax treatment based on the current legislation. Prior Revenue approval is not required to operate the KEEP.
The qualifying company is however, required to make an annual return to Revenue, setting out details regarding all options granted, exercised, assigned or released.
However, reviews show that the uptake of the KEEP scheme have been much lower than originally anticipated, mainly due to a number of practical difficulties and compliance burdens of the scheme.
Therefore, the Government entered into a consultation process on how to improve the KEEP scheme with practitioners and businesses. We have considered some of the proposals suggested during this process which we believe would be a significant improvement if introduced in Budget 2020.
Process of Share Valuation
Under KEEP, share options must be granted at the market value of the same class of shares at the date of grant. The valuation of shares can be complex, especially for small and medium enterprises. Valuations can also be costly and can place a significant burden on smaller companies in trying to incentivise its employees.
In the Government’s strategy paper, the stakeholders who took part of the consultation process suggested:
- Further Revenue guidelines on how to value options;
- A “safe harbour” approach to valuing shares could be adopted;
- Consideration should be given to the length of time a given share valuation remains valid for Revenue’s purposes
The above recommendations are not out of the ordinary either. It is possible to agree a valuation of a company with the Revenue equivalent in the UK, the HMRC, for the purposes of their share scheme, the Enterprise Management Incentive, a share scheme which is similar to KEEP. These valuations from the HMRC are valid for 60 days.
This would be a significant advantage for employers to implement KEEP, as there will be security with the valuation and no risk of Revenue intervention in future years, along with reduced costs on the obtaining a market valuation. We believe it’s unlikely Revenue will implement such an approach.
Conditions relating to the Qualifying individual
Under the KEEP scheme, the individual exercising the qualifying share option must be a full-time employee or director of the qualifying company. They must devote a substantial amount of time (30+ hours a week) to the service of that single company throughout the relevant period. However, in practice, an individual may be a director or employed with one group member, but their services are available to other group companies. It has also been proposed that employees with flexible working hours of less than 30 hours a week should be allowed to qualify.
We believe that the definition of a qualifying individual should be widened to provide flexibility to employees:
- Who carry out some duties for other group companies
- And do not work a full working week
These changes would be beneficial to large domestic groups and also to small businesses that may have part time staff. This would help them in the early growth stage of their business.
Group Structures/Definition of holding company
Under the KEEP scheme, an employee may acquire KEEP shares directly in a company, which is engaged in a qualifying trade or acquire shares in a holding company. The definition of a “holding company” under the existing legislation makes it impractical as essentially the holding company’s business must consist wholly of holding shares of a 100% subsidiary. Holding companies generally do not only own shares and are not always the 100% parent company, which is what is required under the existing provision to qualify for KEEP.
It has been recommended that the holding company definition is widened and is brought in line with Revised Entrepreneur Relief definition of a holding company, which we discussed in a previous article.
We believe that this recommendation is needed as corporate groups are usually complex with various shareholdings and activities. This would also align with other tax legislation already in place and therefore, we believe this can be introduced with a safe understanding from Revenue’s perspective.
The above changes would be a welcome improvement to the current KEEP scheme. The introduction of the scheme was a welcome addition to help business incentivise staff and to allow easier cash flow management for those employees on receiving share awards. However, in its current form the scheme is proving burdensome for businesses to use and the low take up reflects the market attitude to this incentive. We are hopeful of some positive alterations to the scheme when it is announced in Budget 2020.
In our next article, we outline any VAT considerations that the Government should be examining in the upcoming budget.
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