Incentive Plans for Employee-Owned Companies in the U.S. and the UK

As a follow-on to our previous article regarding Employee Stock Ownership Plans (ESOPs) and Employee Ownership Trusts (EOTs), this article will cover how an employee-owned company is able to retain, incentivize and reward key employees via various management incentive plans (MIPs) in the home country and abroad. This article is the second of a five-part series focusing on specific issues for international employees in an EOT and an ESOP.

The creation of an MIP for an employee-owned company involves several stakeholders. The buyer will want to incentivize management after the transaction occurs to retain key staff. The EOT or ESOP trust, as the sole or majority shareholder, also benefits from MIPs because these plans help to retain and motivate key employees who can drive share price growth and align the interests of management with the employee-owners. It is also common for an advisor representing the selling shareholders and/or the company to negotiate an MIP with the trustee of the ESOP in the U.S. or the trustee of the EOT in the UK. These plans are negotiated, along with other transaction details, during the sale process; the terms of which depend upon the number of employees that will participate in the plan, the applicable tax jurisdictions and the purpose of such plan.

MIPs will vary based on both the country of origin, the number of employees the company wants to incentivize and the tax jurisdictions in which foreign employees may reside. When it comes to structuring MIPs for foreign employees, there are many issues and nuances to consider. This article explores those considerations by comparing foreign employees’ compensation and overall incentive packages for participating employees based in the home country, whether they are participating in an ESOP in the U.S. or in an EOT in the UK. 

Employee Stock Ownership Plan Management Incentive Plans

An MIP for an ESOP may be structured as phantom shares, stock appreciation rights or a combination of both. The ESOP trustee may allow a certain pool of units for these plans. Phantom units are shares that are equal to the current share price of the stock. Stock appreciation rights, on the other hand, only have value if the stock price appreciates from the time of granting. Both can be granted under a retention-based or performance-based plan, or a combination of the two. A retention-based MIP could be granted to employees immediately and is subject to time-based vesting. In a performance-based MIP, plans units are either granted or vested when and if certain profitability hurdles are met, such as earnings before interest, taxes, depreciation and amortization; net income or revenue. 

If the operating company has foreign employees, it is important to review various potential social/welfare benefits that are offered in the foreign employees’ countries and the specific tax impacts of those benefits, and to compare the benefit levels to the employees based in the U.S. Certain jurisdictions may tax employees on the value of the allocated ESOP or granted MIP shares immediately, which may not match up with the timing of the employee’s receipt of cash from the ESOP shares or MIP payouts. Also, a benefit plan that mirrors the economics of the ESOP may be taxed in some countries upon the date of grant, as the units appreciate over time or upon vesting, even if the foreign employees have not received actual value. As a result, some foreign employees may not participate in the ESOP or a country-specific share or benefit plan may be necessary; this should be determined on a country-by-country basis.  

Employee Ownership Trust Management Incentive Plans

In the UK, some of the EOT qualifying requirements are restrictive so that any benefits delivered to employees from the EOT are paid out to all employees on the “same terms” (e.g., either all employees receive the same amount, or employees receive different amounts by reference to the same criteria, such as a percentage of their base pay). However, any bonuses and/or share awards granted by the company (rather than the EOT) should not subject to the same restrictive requirements. These relaxed requirements may enable the company to cut through some of the restrictions that may otherwise cause retention issues.

There are many ways for EOTs to retain and incentivize key management personnel in a tax-efficient manner. The company can grant a variety of tax-efficient share plans in the UK for plans designed for all employees, such as a Save As You Earn Scheme (which allows employees to buy shares with their monthly savings for a fixed price, up to a 20% discount of the share’s market value at the date of grant) or a Share Incentive Plan (which allows employees to acquire shares for free or from their gross salary without triggering any income tax or national insurance liability, provided the shares are held in a plan for five years). Both of these UK share plans take advantage of statutory tax breaks in the UK tax law.

The company is also able to grant discretionary share options (where it is able to select only certain key employees to participate in the plan) pursuant to an Enterprise MIP or a Company Share Option Plan. These are also HMRC tax-advantaged, meaning that all commercial growth in the value of the shares subject to the options is subject to UK capital gains tax rather than income tax.   

Therefore, companies controlled by an EOT should be able to grant tax-advantaged share options and/or share awards subject to satisfying the statutory qualifying conditions. It is important to ensure that the grant of any options and/or awards does not result in the breach of the controlling interest requirement, which would trigger a disqualifying event.

Where the UK parent company has a U.S. subsidiary, it is common to grant restricted stock units, incentive stock options and/or restricted stock to key employees in the U.S.

Other Considerations

As always, it is critical to keep track of internationally-mobile employees and the awards that have been provided to them. It is common for an employee of one tax jurisdiction to receive a time-based award and then travel to a different jurisdiction for work before the award has fully vested. In these cases, there will be tax consequences not only in the original country, but any other tax jurisdictions in which the employee/manager has worked. 

An employee who has worked in multiple jurisdictions during the performance period may generate income tax and social tax withholdings in each country visited. And as mentioned earlier, the trigger for the tax liability may not coincide with the timing that cash is available. 

These issues are complex and time-sensitive, so using technology-enabled solutions to assist in tracking work locations is highly recommended. The BDO QuickTrip portal can help companies manage their tax and immigration challenges for employees who travel for work, and BDO’s Global Equity Mobility Solution can help identify where and when tax liabilities may occur for a company’s mobile population as it relates to global equity. Additionally, BDO’s global network extends across 167 countries and territories, with local resources collaborating to reach the best plan options for foreign employees.