There are a number of significant changes announced in the Budget to the tax treatment of employee share and incentive plans, as well as the use of employee trusts to avoid income tax and NICs under PAYE. Some announcements are merely re-iterations of previous announcements. Details of only some of the proposed new changes have been released at this stage, with the most far reaching changes being said to be the subject of a review or consultation. More particularly:
A well-known firm of accountants has been promoting a scheme under which a listed company establishes an HMRC-approve Company Share Option Plan (CSOP) in a subsidiary, options being granted up to the £30,000 limit over shares in the subsidiary with rights entitling the holders to the benefit of all growth in value of the company accruing from the time of grant. The plan was perfectly legitimate under existing legislation, but few commentators believed that HMRC would let this one succeed as it effectively depreciated the initial value of the option shares (so as to maximize the value of options which could be granted within the £30,000 limit) and allowed disproportionate gains to be realized with the benefit of statutory relief from income. The loophole has been blocked, in relation to options granted on and after 24 March 2010, by excluding form eligibility as a CSOP schemes involving the grant of options over shares in a company under the control of a listed company if the shares in question are not themselves of a class listed on a recognized stock exchange.
A little-known provision first introduced in 2004, allows a company to claim a CT deduction for the whole amount of a contribution made to an HMRC-approved Share Incentive Plan (SIP) and used to acquire at least 10% of the issued share capital from individual shareholders, provided the shares are distributed within 10 years (30% in 5 years). [For more detail see our website: Point 3 in “Current ideas…”]. This has, in the eyes of HMRC, been abused by owner-managed companies seeking to extract funds in a capital form and with the benefit of a CT deduction for the monies taken out. A recent First Tier Tribunal judgement (in Grogan – now under appeal) illustrated how HMRC has attacked similar arrangements (under older legislation) using the anti-avoidance provisions in the Transactions in Securities rules (see further below). HMRC has also sought to argue that a deduction is disallowed if the shares are considered to have been purchased at an overvalue – curiously the legislation does not require the shares to be purchased at not more than their “market value” for tax purposes. The new proposal seeks to block the arrangements by disallowing CT relief for the contribution to the SIP (used to buy shares off the company proprietor) if the arrangement has as a main purpose the obtaining of a CT deduction, or an increased deduction. At first sight it seems difficult to envisage on what basis HMRC will judge whether this motive test is satisfied given that the whole purpose of the 2004 legislation was to enable companies to benefit from such a deduction and thereby promote employee ownership ! The new rules will take effect in relation to payments made after 24 March 2010.
From 24 March 2010, HMRC can withdraw approval of a SIP if there is an alteration made to the issued share capital of the plan company, or in the rights attaching to any shares in the company, and this materially affects the value of the plan shares (whether or not any such shares have been awarded under the plan). This seeks to stop artificial manipulation of share rights which could enhance the value of plan shares.
HMRC have again announced a minor legislative change (announced in the pre-Budget Review) imposed by the EU to extend the Enterprise Management Incentives (EMI) regime to overseas companies with a permanent establishment in the UK.
- Payments of bonuses through EBTs
At last (!) “the Government will be [not “is”]taking action to prevent attempts [HMRC do not accept that existing schemes work, despite court decisions to the contrary !] to avoid tax and NICs through the use of Employee Benefit Trusts and other arrangements to disguise payments of remuneration and intends to introduce anti-avoidance legislation to take effect from 6 April 2011″ ! Surely, a polite way of saying we know there’s a problem, but as yet we have no idea how to tackle it. This is backed up by the fact that this particular announcement is made only by the Treasury and is not supported by either a detailed HMRC Press Release or draft legislation. This could be another case of “closing the stable door…..” but for the fact that the Government has the power to legislate with retrospective effect to counter what they see as tax avoidance in this area.
- “Geared-growth arrangements” (eg flowering shares and similar arrangements):
A review and consultation is to be conducted in 2010 in relation to such arrangements used in connection with employment-related securities “to ensure employment income is subject to correct tax and NICs”. So far as we are aware, this is not intended to restrict the legitimate use of Joint Share Ownership Plans (JSOPs) as those which have been established by this firm are on the basis that the employee pays, or is taxed upon, the full initial unrestricted market value of the interest he acquires in the jointly-owned shares. Thereafter any gain realized on the disposal of the jointly-owned shares or of his interest in them, is properly taxed as capital gain. It is, we suspect, those schemes which have sought to push the boundaries and secure disproportionate growth in value, that are likely to be the subject of scrutiny.
- CGT – Entrepreneurs’ relief:
In relation to disposals on or after 6 April 2010, the lifetime limit on gains qualifying for the reduced (effectively) 10% rate of CGT under the rules relating to entrepreneurs’ relief is doubled to £2 million.
- Release of loans to an employees’ share trust (as a participator in a close company):
From 24th March, a deduction for CT purposes is denied (under the loan relationship rules) for the release of a loan to, for example, an employees’ share trust. Such a release can already give rise to an income tax charge on the part of the person whose indebtedness is released or who benefits from such a release.
- Anti-avoidance: transactions in securities:
Following an earlier consultation exercise the rules relating to the countering of tax advantages through transactions in securities [now ss682-713 Income Tax Act 2007] are to be revised and their scope limited to transactions with a tax avoidance purpose. That said, what in our opinion is required, but is not so far alluded to by the Government, is clear guidance from HMRC as to the circumstances in which a sale, to an employees’ trust, of shares in a company for a consideration which is funded (in effect) by loan from the company will be treated as being for “bona fide commercial reasons” so as to not to fall foul of these anti-avoidance rules.
- Disclosure of Tax avoidance Schemes (“DoTAS”):
It appears that the Government is going beyond the changes announced in the pre-Budget Review, and consulted upon earlier in the year, which will extend the obligations to disclose, up-front, schemes and arrangements which relate to the avoidance of employment income or have the effect of substituting capital gains for what would otherwise be employment income. A Consultation Response Document, issued on Budget Day, states that HMRC will revise the regulations issued in draft last year as part of an iterative process. It appears that the scope of the proposed new “hallmarks” (of a disclosable arrangement) will be extended, but be “properly targeted”. In particular, the employment scheme hallmark will be recast as a positive list of schemes to be disclosed. The changes – in regulations – are intended to take effect in the autumn. Penalties for non-compliance are to be increased by changes in legislation. As regards JSOPs, the Document notes that the consultation has “confirmed that the hallmarks do need to be extended to capture various types of avoidance scheme that are not currently being disclosed” (emphasis added). The JSOP has, since 2002 (!) been fully disclosed to, and discussed with, HMRC and is presumably therefore not one of the types of arrangement now being targeted by these proposed changes.
Budget 22nd June 2010
In relation to employee shares and incentives, this Budget is remarkable more for what it does not contain, than for what it does.
Neither the Chancellor’s speech, nor the detailed Notices, make any specific new references to employee share schemes or the tax treatment of shares held by employees in their own company. The lifetime allowance for Entrepreneurs’ Relief (attracting a reduced 10% rate of CGT) is increased to £5 million with immediate effect but, as this applies only to an individual with a 5% shareholding, it is of no help to the vast majority of employees who will, subject to the Annual Exempt Amount (£10,100 for 2010-11) now be subject to a 28% rate on capital gains if or insofar as total taxable income and gains exceed the upper limit of the income tax basic rate band (£37,400 for 2010-11).
No exception from the application of the higher rate charge to CGT has been made for gains realised upon the disposal of, or of interests in, employment-related securities – employee shares are treated in the same way as any other chargeable assets. No form of taper relief has been re-introduced.
- Share option/LTIP gains:
This reduces the attraction of CSOP and Enterprise Management Incentive share options, although many employees holding SAYE options will still expect to avoid paying CGT on gains when option shares are sold at least to the extent that such gains fall within the £10,100 Annual Exempt Amount (the “AEA”).
Nevertheless, CSOP, SAYE and EMI share options still remain attractive even at the new CGT rate of 28% when compared with an effective rate of income tax plus employers’/employees NICs on unapproved option gains, of 58.9% (for 2011-12), assuming a full transfer to the employee of the employers’ NICs.
The fact that CT rates are to be reduced is likely to make it more worthwhile for an employer company to transfer to an employee optionholder the burden of employers’ 13.8% NICs (from 2011-12).
- EMI share options
Existing EMI share option holders, whose gains are in excess of the AEA are significantly worse off than when the EMI regime was first introduced in 2000 : with the benefit of time running from the date of grant for taper relief purposes, the effective rate of CGT was commonly as low as 10%. From 2008 until today, it was a flat rate of 18%. Now it is 28%. This may create a tension within those smaller, high-growth, companies (at which the EMI regime was aimed) who have attracted senior employees from safer and higher paid employment in larger companies with the prospect that will instead have the opportunity to benefit from growth in value subject to tax at relatively low rates. These are, after all, the companies expected to be at the heart of the economic recovery!
On the bright side, the exemptions from income tax, NICs and CGT for so long as shares awarded to employees remain in the SIP, have survived and, given the increase in CGT rates, SIPs have consequently become even more attractive relative to other HMRC-approved plans for all employees.
Sadly though, no changes to the existing tax treatment of SIPs have been announced. It would take only a small change – removal of the risk of a penal clawback if the company is sold within 3 years – for SIPs to become very much more attractive as a tool for promoting employee share ownership in smaller and privately-owned companies (in particular).
The attraction of Joint Share Ownership Plans, relative to unapproved share options/LTIPs, is reduced – having regard to the increased rate of CGT and the lack of any CT relief for the gain realised by the employee – but they remain an attractive incentive arrangements in those cases in which significant growth in value is anticipated (albeit not guaranteed !).
Early modelling suggests that, for employees (including directors) who anticipate paying income tax at the 50% additional rate – and who do not expect the Coalition Government to succeed in bringing down that top rate in the life of the current Parliament – the savings will still be worthwhile. The difference between 28% and up to 58.9%, in personal tax rates, when compared with the loss of CT relief (at rates reducing, at 1% per annum, to 24% in 2014-15), mean that the JSOP should, subject always to financial modelling in every case, remain attractive notwithstanding the upfront charge to income tax and NICs on any amount of the initial unrestricted market value (IUMV) of the employee’s interest not paid up.
Hidden in the “small print” is a confirmation that the consultation, announced in March 2010 on the taxation of “geared growth” schemes (which includes the JSOP), is being undertaken during this year. However, there is a subtle change in the wording describing its purpose : the aim is now “…to develop proposals to ensure that employment income from employment-related securities is subject to income tax and NICs.” [Emphasis added]. The earlier announcement referred to “…[ensuring] employment income is subject to correct tax and NICs”. Are we just becoming paranoid….?