Draft Finance Bill 2014 contains more than 100 pages on employee share schemes. Key clauses on approved schemes provide for a switch from HMRC approval to self-certification and increases in the limits for SAYE option schemes and SIPs. For unapproved schemes, draft provisions take forward some of the OTS’s recommendations, including: changing the basis of the taxation of shares and options granted to internationally mobile employees; introducing a new rollover relief for certain share exchange arrangements; and extending corporation tax relief for employee share acquisitions.
This article was written for and first featured in the Tax Journal
Change from HMRC approval to self-certification
Most of the approved scheme changes involve implementation of the already announced decision to abolish the requirement for prior HMRC approval of a scheme and to replace it with a self-certification process.
This will take effect from 6 April 2014. Once a company has set up a scheme, it must notify HMRC of the new scheme’s existence before 6 July in the tax year after that in which the first options or shares are awarded. Late notice will mean that the scheme will only qualify for tax- advantaged status from the beginning of the tax year preceding that in which the notice is given or, if the notice is given after 6 July, the tax year in which it is given. The requirement is not restricted to new schemes. Notice must be given on or before 6 July 2015 for plans established and approved before 6 April 2014.
Under current legislation, HMRC approval is required during the life of a scheme for an alteration to any of its ‘key features’ or an adjustment to the terms of subsisting options to take account of a variation of share capital. Naturally, under the new regime, these approvals will also fall by the wayside. Instead, the company will be required to certify that an alteration does not cause the scheme to cease to satisfy the statutory conditions and that an adjustment of options will leave unchanged the total market value of the shares under option and the total exercise price.
Advisers will be understandably nervous about being deprived of the comfort blanket of HMRC approval and anxious about the responsibility to be placed upon their shoulders. Obviously, the nightmare scenario is that a scheme which does not meet all the statutory conditions is mistakenly certified and the error is only unearthed by HMRC after significant awards have already been made. The truth is that, unless the company is seeking to operate its scheme to achieve tax advantages beyond the norm, certification should largely be a box-ticking exercise. The one clear exception to this would have been the requirement that the purpose of an approved scheme must be to enable employees to become shareholders and that the scheme must not involve ‘features which are neither essential nor reasonably incidental’ to that purpose.
The question of which features would fail this test is necessarily subjective and therefore unsuitable for a regime of self-certification. Instead, for plans set up from 6 April 2014, all that is required is for the relevant plan not to ‘provide benefits to employees otherwise than in accordance with’ the relevant schedule of ITEPA 2003. This would appear to be a statement of the obvious, were it not for the fact that this will be followed in each case by the ‘example’ that cash must not be provided as an alternative to share options or shares. Is this merely an example? Past practice suggests that HMRC’s main use of ‘features neither essential nor reasonably incidental’ has been to prohibit cash alternatives. If it is only an example, then HMRC guidance will be required as to what other structures are prohibited. Nor is the question of what constitutes a cash alternative a straightforward matter. HMRC has always allowed a company offering free shares under a share incentive plan (SIP) to inform its employees that those who decline the offer will be considered for a cash bonus which may be of an equivalent value. Provided the plan itself makes no reference to cash and the cash is not guaranteed, no objection is taken. It is to be hoped that HMRC will confirm that this continues to be the case.
Hand in hand with self-certification, the modernisation drive will include the requirement that annual returns and other notifications from scheme companies must generally be given electronically. The data to be included on the return will be prescribed by HMRC, giving it the opportunity to garner information which is presently a product of the approval process.
Finally, there will be a change in nomenclature. Out goes ‘approved’ and in will come ‘Schedule 2 share incentive plan’, ‘Schedule 3 SAYE option scheme’ and ‘Schedule 4 CSOP scheme’ (the schedule numbers being schedules of ITEPA 2003).
Increases in limits for SAYE option schemes and SIPs
The increases in the individual limits for approved all-employee share schemes, announced by the chancellor in the Autumn Statement, will take effect on 6 April 2014. The increase to the save as you earn (SAYE) limit is the first since 1991 and the SIP limits have not changed since SIPs were introduced 13 years ago. But though this suggests that these increases are long overdue, the number of employees who will actually benefit is likely to be relatively small.
The SAYE maximum monthly contribution will increase from £250 to £500. This means, for someone taking out a three-year share option, an increase from £9,000 to £18,000. However, HMRC statistics show that an average employee saves only about £3,800 – equating to a monthly contribution of barely more than £100. Even those already saving £250 may cavil at putting more of their savings into a product which since August 2011 has paid a bonus rate of precisely zero.
The more modest increases for SIPs should actually have a somewhat greater impact. The rise in the amount of pre-tax salary which an employee can invest in ‘partnership shares’ from £1,500 to £1,800 will be attractive to many. The annual limit for ‘free shares’ will also go up by 20% – from £3,000 to £3,600.
Existing schemes rules will need to be checked to ascertain whether these increases will take effect automatically or if amendments will be required.
Unapproved employee share schemes
Five of the recommendations of the Office of Tax Simplification (OTS) are being taken forward.
First, the tax and NIC rules for shares and share options awarded to ‘internationally mobile employees’ will be more closely aligned to those which already apply to other types of employment income. This will involve the establishment of ‘relevant periods’ for each category of employment-related securities and apportionment within these periods to determine the amounts chargeable in the UK.
Second, whereas the exchange of one non- approved share option for another is never a taxable event, there is no such ‘rollover’ relief where the exchange involves restricted shares. ITEPA 2003 Part 7 Chapter 2 will be amended to remove this anomaly.
Third, ITEPA 2003 Part 7 Chapter 3C imposes an income tax charge on the acquisition of nil paid or partly paid employment-related securities. The amount remaining unpaid is treated as if it were a beneficial loan and taxed on an ongoing basis, as well as if the shares are sold before they have been fully paid up. The latter creates a trap which is illustrated by the following example.
An executive is issued with shares worth £1.50 per share on which he pays up 80p per share. The value falls to £1.20 at which point he sells for 50p reflecting the fact that the purchaser will take on the liability to pay up 70p. The effect of Chapter 3C as currently drafted is that the executive will be subject to income tax on the unpaid amount of 70p (because his liability to pay that has been discharged) even though he has actually suffered a loss of 30p.
The Finance Bill will remove this injustice by providing that, if the purchaser of the shares also takes on the liability to pay them up, the selling employee will not be taxed on that amount.
Fourth, it is a condition of corporation tax relief for employee share acquisitions that the shares must be in a company which is either under the control of a listed company or is an independent company.
This means that if shares in an unlisted company are acquired after that company has been taken over by another unlisted company, CT relief is lost. Under the Finance Bill, relief will be preserved if the shares are acquired within 90 days of the takeover.
Fifth, ITEPA 2003 s 222 is one of the most detested provisions in the whole of the UK tax code. It provides that if an employee is taxable on the exercise of an unapproved share option or on another ‘notional payment’ and does not ‘make good’ the amount of tax to the employer within 90 days of the date of exercise, the amount of tax is treated as additional earnings and taxed at the employee’s marginal rate, as well as being subject to NIC. HMRC generally applies the letter of the law, which is that even if payment is made after 91 days, there is no reprieve from s 222.
The proposed remedy is that the payment deadline will be extended to 90 days after the end of the tax year in which the option is exercised. This will not necessarily solve the problem where there is genuine unresolved doubt as to whether a liability has arisen. Hopefully, promised guidance from HMRC on the meaning of ‘make good’ may extract much of the residual poison from s 222.
The change to s 222 will come into effect on 6 April 2014. The changes in relation to internationally mobile employees will apply to grants made on or after 1 September 2014. The other three changes will apply from the date on which the Finance Bill receives Royal Assent.
For the last couple of years, the OTS has been focusing its attention first on HMRC approved employee share schemes and then on non- approved schemes. When, on 10 December, HMRC published draft clauses to be included in the 2014 Finance Bill, more than 100 pages were devoted to share schemes. If this seems a strange way to simplify, the hope must be that the pain of getting to grips with all this additional statutory material will translate into long-term gain for advisers and their clients – and perhaps even for HMRC.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.