Key Employee Engagement Programme (KEEP)

July 16, 2020

KEEP was introduced to help SMEs attract and retain key talent. It does so by making it tax efficient to issue share options to employees. When initially introduced the scheme was very well received in a sector that struggles to compete with the pay packages offered by larger organisations.  However, due to its limitations and extensive qualifying conditions only a small number of companies have availed of the scheme. Finance Act 2019 introduced some changes to address these limitations. In this article we take a closer look at the scheme and whether these changes succeed in making it more attractive to Irish businesses.    

How does the relief operate?

KEEP applies to share options granted during the period 1 January 2018 to 31 December 2023. Under the terms of a share option agreement, an employee is granted a right to exercise an option to acquire shares at an agreed price at some time in the future. Subject to meeting the qualifying conditions, there is no income tax, USC or PRSI on the grant or exercise of the KEEP options and CGT applies on a disposal of the shares. This contrasts with the tax treatment of standard share option schemes where income tax, USC and PRSI is payable on the exercise of the options and also, in certain circumstances, on the grant. This often presents cashflow difficulties making standard options unviable in many instances.  

Worked example

The following example best illustrates the advantages of KEEP options over standard share options.

• Options provided on 10/06/2020 to purchase 50,000 €1 shares at €50,000 (market value at date of grant)
• 10/06/2023: shares are worth €3 per share so employee exercises the option and purchases for €50,000, i.e. benefitting from a discount of €100,000
• 10/06/2026: shares are worth €4 per share and individual sells for €200,000. Assume the employee is liable to income tax at the higher rate of 40% and USC at 8% in 2020.

The fine print

The above example shows the clear benefits of KEEP – a reduction in the overall tax payable and no tax liability and associated negative cash flow on exercise of the options.  However, to qualify for KEEP there are a number of conditions that must be met.

The employee/director:

• Must be a full-time employee/director (30 plus hours per week) of a qualifying company during the grant to vest period (Finance Act 2019 has extended KEEP to part-time employees however the Finance Act amendments require EU approval and so have not yet taken effect).
• Their employment must be capable of lasting at least 12 months from option grant and they must hold the options for at least 12 months prior to exercising.
• Cannot hold a material interest (15%) in the qualifying company.

The shares options must be:

• In respect of new ordinary fully paid up shares in a qualifying company, which carry no present or future preferential right to dividends or to a company’s assets on its winding up;  (Finance Act 2019 has deleted the requirement for shares to be new shares and also the prohibition on the shares having any preferential rights to dividends or assets on a winding up.  As set out above, these changes require EU approval and so have not yet taken effect.)
• Granted at not less than the market value of the same class of shares at the date of grant;
• Subject to a written contract or agreement setting out the relevant details i.e. number and description of shares which may be acquired by the exercise of the option, the option price and the period during which options may be exercised;
• Within the maximum permitted limit in terms of awards per employee i.e. not more than €100,000 per employee in any one year; a €300,000 lifetime limit and not more than the employee’s annual emoluments in the year the share option is granted, and
• Exercisable after 12 months from the date of grant and must not be exercisable more than 10 years from the date of grant.

The company over whose shares the option is granted must be:

• Incorporated and resident in the State or resident in another EEA State and carrying on business in Ireland through a branch or agency;
• In existence wholly or mainly for the purpose of carrying on a “qualifying trade” on a commercial basis with a view to the realisation of profit. A qualifying trade excludes the following activities: financial activities, professional services companies, dealing in or developing land, building and construction, forestry or operations in the coal, steel or shipbuilding industries;
• A micro, small or medium-sized enterprise (“SME”), which is defined as an enterprise which has less than 250 employees, has an annual turnover not exceeding €50 million and/or an annual balance sheet total not exceeding €43 million;
• An unquoted company none of whose shares, stock or debentures are listed in the official list of a stock exchange or quoted on an unlisted securities market of a stock exchange, other than on the Enterprise Securities Market of the Irish Stock Exchange or on any similar or corresponding stock exchange in an EEA country or a country with which Ireland has a double taxation agreement;
• Must not be regarded as a company in difficulty for the purposes of EC Commission Guidelines on State Aid, and
• Must not issue qualifying share options with a market value exceeding €3,000,000.

Options may be granted over shares in a holding company of a company which satisfies the above conditions (a “qualifying company”).  There are limitations on the type of holding company which can qualify.  The holding company’s only business must be holding shares in a qualifying company.  (Finance Act 2019 has extended the circumstances in which options may be granted in a holding company to ones with more than one subsidiary, directly or indirectly held although only directly held subsidiaries can be a qualifying company.  The holding company’s business must consist wholly or mainly (>50%) of holding shares in its subsidiaries but it cannot carry on a trade.  The activities of the group, excluding the holding company, must consist wholly or mainly of carrying on a trade.  These changes are subject to EU approval and have not yet taken effect.) 

KEEP Limitations

Data issued in May 2019 shows only 38 employees availed of the scheme in 2018.  The low uptake is partly due to the following limitations in the scheme.

• The option price must be no less than the market value of the shares on grant. This presents a number of difficulties for SMEs:
  • It may be difficult to determine the market price of the shares. Although the scheme does not require Revenue’s prior approval, if Revenue determine the valuation of the options granted is below market value, KEEP provisions will not apply and income tax may arise on exercise or relief previously given may be withdrawn.
  • From a cashflow perspective, how does the employee fund the option price on exercise if there is no ready market for the shares or future exit anticipated?
• The amount of KEEP options granted in a year is limited to the employee’s emoluments for that year. If an employee is on a low salary this hinders the company’s ability to incentivise them with an attractive equity package.
• Excluded companies include companies involved in financial services which disqualifies many fintech start-ups.  
• Where relief applies under KEEP, relief cannot also be claimed under the Employment and Investment Incentive (EII).
• A buyback of the shares by the company would likely be liable to income tax, USC and PRSI.  Although a buyback of shares can qualify for CGT treatment if certain conditions are satisfied, it is unlikely that these conditions would be satisfied for a buyback of employee shares. As such, a third party would need to purchase the KEEP shares which may not be suitable to family companies as they would not want to sell shares outside the family.

Finance Act 2019 Amendments

The Finance Act 2019 proposed some welcome extensions to the KEEP share scheme for which EU approval is required and accordingly which will not take effect until a Ministerial Commencement Order is signed.

• The scheme has been extended to share options over shares in a wider range of holding companies.
• It is no longer a requirement for the employee to work full-time in order to qualify for the scheme, and
• Shares no longer have to be newly issued shares in order to qualify and can have preferential rights to dividends and/or assets on a winding up.

We will have to wait and see whether these changes are significant enough to increase the uptake on the relief and provide much needed assistance to SMEs in attracting and retaining talent. The full impact of Covid-19 on Irish SMEs is also yet to be seen. Many larger organisations will be better placed to withstand the medium-long term impacts. As we emerge from the far side of this crisis supports and measures such as KEEP will play a more crucial role in helping SMEs find their feet again and it is critical these measures are fit for purpose.

No action should be taken on the basis of the above without obtaining professional taxation advice. 

If you have any queries in relation to KEEP share scheme please do not hesitate to contact Purcell McQuillan Tax Partners Ltd on 01 668 2700 or email your usual PMQ contact.