When Revolut’s share plan controversy left former employees facing unexpected income tax liabilities, the legal community’s interest was understandable. Here, after all, was a high-profile illustration of what happens when the legal and tax architecture underpinning an employee share scheme is either poorly designed, poorly communicated or inadequately maintained.
The case attracted attention partly because of the sums involved and partly because of the company’s profile. But the legal issues at its heart are neither unusual nor confined to high-growth technology businesses.
The same failure modes of misunderstood tax treatment, inadequate leaver provisions, poor communication with participants and process breakdowns at key trigger points arise regularly in businesses of every size. For those advising owner-managed businesses, SMEs or growing companies, they are a familiar source of contentious and non-contentious work alike.
The legal complexity of share plans
Employee share schemes operate at the intersection of employment law, tax law and corporate governance. This intersection is a complicated place, and the complexity is compounded by the fact that the legal and tax position is rarely static. The conditions for tax-advantaged status must be continuously maintained; corporate events change the landscape; and legislation and HMRC’s requirements evolve.
The principal tax-advantaged structures available to UK companies are the Enterprise Management Incentive (EMI), the Company Share Option Plan (CSOP), the Share Incentive Plan (SIP), and the Save As You Earn (SAYE) scheme.
Each carries its own eligibility criteria, statutory conditions, HMRC notification requirements and ongoing compliance obligations. Each of these share plans allows companies to agree a valuation with HMRC (thereby obtaining certainty of the value of the options being granted or shares being awarded). Annual reporting via the Employment Related Securities (ERS) online service, and notification of grants all need to be done.
EMI is the most flexible and widely used scheme for smaller private companies. However, failure to meet the various statutory requirements and remaining within the qualifying criteria of the EMI does not merely create an administrative inconvenience, but can cause options to lose their tax-advantaged status entirely, with consequences falling on both the employee and the company at exercise.
For those advising on these schemes, the challenge is often not the initial setup, where specialist input is routinely obtained, but the ongoing management, where it frequently is not. Clients tend to treat the execution of a scheme as the endpoint rather than the starting point of their obligations.
Where things go wrong
Experience suggests that the problems that give rise to legal disputes or regulatory exposure tend to cluster around a small number of recurring issues.
Leaver provisions
This is consistently the most fertile source of disputes. Businesses often implement schemes without adequately considering what happens when a participant leaves. Good leaver and bad leaver provisions need to be clearly defined in the scheme rules and properly aligned with the company’s Articles of Association. Where there is ambiguity between the two documents, the scope for dispute is considerable. Companies also need internal processes to ensure that leaver treatment is actioned promptly, as delay can affect the tax position and, in some cases, the enforceability of the company’s rights.
Corporate events
Funding rounds, restructuring, acquisitions and exits each represent a trigger point when the legal and tax position of scheme participants may change materially. Clients who have not considered or sought advice before these events, or who have proceeded without first checking the details of their share plan arrangements, may find that the impact of such events is not necessarily what was anticipated. For example, changes to share capital can in some circumstances, disqualify tax advantaged share plans; and where an exit event such as a sale happens, target companies should expect detailed share plans due diligence to be carried out as part of the process.
HMRC filings and notifications
Annual ERS returns must be submitted by 6 July following the tax year in question, with a separate notification of the grant of any EMI awards in the period also due. Late or incorrect filings attract penalties and, for EMI, can affect the qualifying status of options. The HMRC online system for ERS reporting has historically been a source of difficulty for businesses unfamiliar with it. Clients should be advised that compliance in this area is an ongoing annual obligation, not a one-off exercise.
Share register management
In the context of a corporate transaction, an incomplete or inaccessible share register or option register can create significant practical problems. Former employees who hold shares or have exercised options remain shareholders with attendant rights. If a business cannot locate them when a liquidity event occurs, completion can be delayed or, in extreme cases, jeopardised. This risk is disproportionately prevalent in businesses that have experienced rapid headcount growth or where share administration has been lax.
Communication failures
The Revolut case illustrated the consequences of a gap between what employees are told about their equity and what they actually receive. Representations made to employees about the tax treatment or expected value of their shares can, depending on the circumstances, create legal exposure for the company if those representations prove incorrect. Professionals advising on scheme documentation should encourage clients to ensure that communications to participants are accurate, include appropriate caveats and are consistent with the scheme rules.
Best practice for scheme management
The scheme rules, option agreements and related corporate documentation should be reviewed regularly and updated to reflect changes in the business, its ownership structure, and the applicable legislative framework.
Legal and tax advice should be obtained not just at the point of scheme establishment, but at each subsequent trigger point: grant, exercise, corporate events, and on the departure of participants. The cost of advice at these points is almost always lower than the cost of resolving problems that arise from its absence.
The definitions of good leaver and bad leaver should be tailored to the circumstances of the business, not imported from a template without consideration. They should be consistent with the Articles of Association and, where relevant, any shareholders’ agreement. The process for determining leaver status, and the timescales within which the company must act, should be clearly set out and understood by those responsible for HR and employee offboarding.
Companies should be advised against making definitive statements to employees about the tax treatment or financial value of their options or shares, as both can change – tax treatment through legislative amendment or changes in the employee’s personal circumstances, financial value through the many factors that affect business performance and exit outcomes. Scheme communications should clearly direct participants to seek independent advice on their personal tax position.
The share register should be accurate, up to date, and accessible to those who need it. In an owner-managed business, this means ensuring that whoever is responsible for employee departures has access to the register and understands the actions required when an employee shareholder leaves. Contact details for shareholders should be maintained and periodically verified. During a transaction, the buyers’ solicitors will scrutinise the register carefully, with any deficiencies creating risk and, potentially, price-chipping opportunities.
A note for law firms
It is worth observing that the principles above apply to law firms that operate their own share or equity incentive arrangements. The legal profession is not immune to the failure modes described here, and the growth of alternative business structures and incorporated law firms has brought share-based incentives into wider use within the sector.
Firms that use equity to attract and retain talent, and whose people may have the same expectations of their arrangements that employees at any other business would have, face the same compliance obligations and the same reputational consequences if things go wrong.
Whilst the Revolut story will fade from the headlines, the legal and structural lessons it offers will endure. Employee equity is only as valuable as the trust, precision and ongoing diligence that surrounds it.
For more than 30 years, Sarah Anderson has worked with private company owners to set up employee share plan arrangements, guiding and supporting businesses through the establishment and ongoing life of their schemes. A qualified solicitor, she has worked with several of the leading share plans practitioners, including a period with the Office of Tax Simplification, when she advised on policy relating to the simplification of tax legislation governing share plans.
Formed in 1991, RM2 became an employee-owned business in 2019, through the Employee Ownership Trust model, which it has helped implement for more than 150 other privately owned businesses. Team members have helped clients design and administer all types of employee share schemes for UK companies and continue to help shape Share Incentive Plan (“SIP”) and Enterprise Management Incentive (“EMI”) legislation and other government-sponsored employee share plans.
Photo by Dylan Gillis on Unsplash.
