introduction
One of the most effective ways to motivate employees, especially executives, is to give them the opportunity to purchase shares or interests in a group company. US companies often have stock and other incentive plans that apply the same terms to their international employees as their US employees, often for good reasons such as consistency and ease of administration. However, care must be taken to ensure that certain tax, employment and regulatory requirements in each jurisdiction do not affect the effectiveness of the company’s incentive agreements. The use of sub-plans or bespoke grant documents that vary the application of the rules of the entire U.S. plan to reflect UK law and the tax context can be essential in avoiding difficulties encountered in a variety of areas.
Limiting Clauses
It is common for US incentive plans to include non-compete agreements and other restrictive covenants upon termination of the contract as conditions for granting the appropriate incentive. It is important to note, however, that post-contract non-compete and other restrictive covenant provisions that are perfectly valid and enforceable in the US – or at least certain states in the US – may not be automatically enforceable in the UK – even if they do The applicable law of the incentive plan concerned is deemed to be the law of a US state.
Even if a restrictive contract is enforceable under the applicable law of the scheme in question, the courts of England and Wales will not enforce contracts that are unenforceable when judged by the standards of the law of England and Wales and public order. The test of the enforceability of non-compete agreements and other post-termination restrictive agreements under English law, to paraphrase, is that they must go no further than what is in scope and duration to protect the employer’s legitimate business interests with respect to confidential information is appropriate. Goodwill, customer loyalty and a stable workforce. This test is no different from the test in the United States, where restrictive agreements may be enforceable.
However, the detailed case law in England and Wales, which often focuses far more precisely on the details of how a particular pact is drafted and implemented in determining its enforceability, can make a restrictive pact unenforceable while the executive still has the right to maintain the pact taking advantage of the incentive in question. Design issues that jeopardize the enforceability of restrictive agreements once terminated by the courts of England and Wales can arise in a number of ways, including the length of the contract, the definition of its geographical scope, and the degree of involvement of the restricted executive in the deal. Employees and customers who are to be protected by the applicable agreements are sufficiently narrow and precisely defined. A careful review of the enforceability of the restrictive requirements contained in a US equity incentive plan and appropriate changes to the relevant restrictive requirements may be required in order to address any concerns.
Ideally, a company that provides incentive rewards to executives in England and Wales does not rely solely on the rules of the respective protection plan through restrictive post-termination agreements. Because incentive plans work with executive employment contracts, the company may wish to ensure that executives’ employment contracts contain up-to-date and appropriately worded confidential information, intellectual property, and restrictive covenants that will help meet corporate security goals. If a manager’s contractual arrangements need to be updated, agreeing to a revised and updated employment contract may be a condition of the grant.
Notice periods and garden leave
The impact of contractual notice must also be taken into account when applying US incentive plans to executives in England and Wales (and indeed other European countries). The rules of a US incentive plan may state that an executive’s entitlements expire immediately upon termination of employment. This is consistent with the fact that in the United States, executive recruitment is generally “ad libitum” and therefore may be terminated without notice from either party. In England and Wales, however, almost without exception, managers are entitled to a contractual notice period which must be given to the manager before the employment relationship is terminated. If an incentive plan provides that their entitlements do not end until termination (if any), their current vesting period and their potential ability to exercise their options will remain in effect during and until the end of the executive’s notice period. This is also the case if the manager does not work for the notice period but is put on “garden vacation”, whereby the manager is not provided with any work according to an express provision of the manager’s employment contract, but continues to be employed by the manager Employer and unable to work elsewhere, keeping the individual out of the market for the notice period. The Company may not want the Executive to retain their ongoing benefits under the Incentive Plan for the notice period, but the Executive may wish to maintain their notice period.
If the company wishes to maintain this flexibility and avoid a continued vesting period and the possibility of exercising an incentive bonus after the notice of termination has been served by the employer or the employee, the rules of the incentive plan (or the applicable sub-plan or grant documentation) should specify that the Exercise and the ability to exercise an incentive bonus should cease at the earlier date of the granting or receipt of the notice of termination of the employment relationship and the day on which the employment relationship actually ends.
Claims for loss of incentive rights
It is customary in stock option plans operating in England and Wales to include a provision that the individual’s rights under the plan are entirely separate from the individual’s employment contract and that termination of employment does not create an entitlement to loss of rights out of plan. While this type of clause is ineffective in preventing claims for loss of stock options in the event of an unfair dismissal or unlawful discrimination lawsuit, it prevents an executive from including the loss of stock incentives in a breach of contract compensation claim. Without such a provision, a manager – especially one with a long contractual notice period who is wrongly dismissed for breach of contract – could demand compensation for the loss of value of incentives that would otherwise have been vested and exercisable during the notice period. There are no such provisions in the US plans. Hence, it is advisable to include them in sub-plans or to provide executive documents in England and Wales.
Tax-approved stock option plans
In general, the use of an “unapproved” form of option agreement is tax inefficient and subjects UK employees to income tax (up to 45 percent) on the value of equity received at the time of acquisition less the exercise price paid. Social Security liabilities in the form of Social Security Contributions (“NICs”) from employers and employees may also arise, as explained below. In contrast, using a tax-privileged form of procurement can potentially result in a much better tax return on tax investment income for UK workers (with a 20 percent tax). There are several forms of tax-privileged incentives in the UK, the most common of which is the Enterprise Management Incentive (“EMI”) stock option. Although detailed conditions must be met in order to grant EMI options (and other types of tax-privileged awards), it can be relatively easy for qualifying companies to align US-style allocation documentation with UK requirements for EMI stock options. Offering tax-privileged bonuses to UK employees should add significantly to the appeal of the company’s overall incentive package.
Social security taxes
When a UK employee is subject to income tax in relation to an Incentive Reward, there is often a corresponding NIC fee for both the employee and the employer. The employer’s fee is 13.8 percent of the income taxable amount, so it can represent a significant additional cost to the employer awarding the award. When using the standard documentation for US rewards, UK social security contributions are rarely covered in sufficient detail, and no provision is usually made regarding the employer’s NIC. It is generally illegal under English law to rely on a general withholding tax law to pass these costs on to the employee. With appropriate review and advice in the UK, the planning documentation may be amended to include any NIC liability of the employer in the value of the award given to or transferred to the employee in certain scenarios.
Control point
In the United States, the date a bonus is exercised is typically a chargeable event. In the UK, however, the exercise date of an award based on stock options is generally not a chargeable event. Instead, tax does not become due until the option is exercised. Adjustments may be required to schedule documents to reflect this difference and to ensure that tax withholding can occur at the right time.
Tax elections
UK employees are often required to run tax elections as a prerequisite for receiving stock-based awards to tax the full unrestricted market value of employment-related stock at the time of purchase (broadly similar to the U.S. 83 (b) election). Such a choice should ensure that the recipient will benefit from the tax treatment of investment income in the event of future growth and should avoid additional income taxes in the future and, above all, from the employer’s point of view, NIC.
Conclusions
Employers want to ensure that their international incentive agreements are fit for purpose from an employment tax and regulatory perspective. It is advisable to seek expert advice at an early stage and, if necessary, to incorporate flexibility into the drafting of the plan in order to take into account the local legal requirements for the international introduction of US incentive agreements.