The coalition Government is continuing the approach of previous UK governments in seeking to combat perceived improper avoidance of tax. One element to be included in the Finance Bill 2011 concerns arrangements using Employee Benefit Trusts (EBTs) and similar structures to provide benefits to employees or connected persons in a manner which defers income tax or NICs, or avoids those charges entirely.   These aren't intended to affect legitimate employee share plans but any company which has an EBT should consider whether any of its activities might be affected.
 
Although it is understood that the primary targets include family benefit trusts (employer-funded discretionary trusts) and some types of retirement benefit scheme, the legislation, like so many anti-avoidance provisions, is complicated and is drafted very widely.
 
There has been some comment that the legislation may therefore affect mainstream employee incentive arrangements, although HM Revenue & Customs has confirmed that it is not intended to interfere with the operation of ordinary share plans with no tax avoidance motive. There is, however, an opportunity for questions and concerns to be raised with HMRC before 9 February 2011 if interested parties wish to air any particular issues.
 
Broadly, under the legislation, an income tax charge will arise when, at any time on or after 6 April 2011, a third party makes a payment or transfer or otherwise makes available property in favour of past, present or prospective employees or directors, or persons linked to such employee or director, under an arrangement connected with the relevant employment or office. This means, for example, that a loan will be charged to income tax when made, rather than only if and when written off, as currently. 
 
There are, however, specific “safe harbour” exemptions for tax favoured employee share and share option plans, registered pension schemes, employment-related securities options and certain types of restricted securities.
 
There are also detailed provisions to deal with the interaction of the proposed new provisions with existing income tax charging provisions, for example, on interest-free loans.
 
In summary, this area of the law is becoming more complex, and technical advice will often be required which will typically depend on the precise circumstances of each individual case. Nevertheless, companies which operate straightforward employee share schemes should have no major cause for concern.
 
Employee benefit trusts continue to be appropriate, and even necessary, in many employee share plans, although some companies may need to seek assurance regarding some technical issues in the light of the proposed new legislation. Companies which have EBTs – or are thinking about creating one – and which are concerned about the possible impact of this legislation should also note the specific “safe harbour” provisions. In the light of these, it might be worth them considering the advantages of any tax favoured employee share and share option plans of which they are not making full use.
 

DOTAS hallmarks will identify schemes to be disclosed to HMRC
HM Revenue & Customs has recently produced guidance on features required to be disclosed under the DOTAS regime (Disclosure of Tax Avoidance Schemes). These features are termed “hallmarks”.
 
This guidance updates HMRC’s previous consultation in which the hallmarks proposed by HMRC were widely considered to be drawn too broadly. In particular, HMRC undertook to identify positive hallmarks (describing the types of schemes required to be disclosed) rather than a negative one (a broad description with a list of exceptions).
 
HMRC anticipates an increase in growth share schemes
HMRC is particularly interested in the use of "growth share schemes" which "involve a class of shares, not available to ordinary investors, whose rights are such that they have a low value at issue, or acquisition, but potential for significant appreciation if the company grows in value. In tax terms they usually involve a relatively low up-front income tax charge to the employee, with capital gains tax treatment on disposal of the shares."
 
Now that anti-avoidance provisions in relation to third party remuneration (disguised remuneration) are in force, HMRC anticipates that one response might be an increase in the number of growth share schemes. It is keen, therefore, that all such schemes are disclosed so that it can decide whether any action, such as further anti-avoidance legislation, is appropriate.
 
HMRC believes that there is a need for hallmarks that capture such arrangements and to this end it will be discussing the scope with interested parties, such as promoters, representative bodies and other persons who have participated in the previous consultation exercise. 
 
While the general principles underlying HMRC’s approach might appear reasonable, there remain questions about how these will be applied in practice. Shares of whatever class in private companies are not generally available to private investors, and ordinary shares of any company with debt or even preference shares could be said to have the potential for significant appreciation. That is what gearing is about.
 
It is not yet clear how HMRC will treat joint-ownership share arrangements
 It remains to be seen, therefore, how HMRC will distinguish between tax avoidance and normal commercial arrangements, and how HMRC will treat joint-ownership share arrangements, which have a similar effect to growth shares but which make use of conventional classes of shares.
 

Significant change to the PAYE treatment of payments to former employees
New PAYE regulations were published on 14 March 2011 which make a significant change to the PAYE treatment of payments to former employees. The total tax ultimately payable in respect of each such payment has not changed (and there is no change to the way in which the NIC liability operates), but the method of collection and the duties on employers will change with effect from 6 April 2011.
 
At present, and until 6 April 2011, an employer must use the BR code for PAYE purposes when making a payment where a Form P45 has already been issued to the former employee. This means that tax is deducted only at basic rate, and any further tax is collected under the self-assessment regime after the end of the relevant tax year. This obviously has cash flow advantages for employees who pay tax at the higher or additional rates.
 
Method of collection and the duties on employers will change with effect from 6 April 2011
From 6 April 2011, an employer must use the 0T tax code which applies on a “non-cumulative” basis. This means that none of the personal allowance is available and, for an employee who is paid on a monthly basis, only 1/12th of the basic rate band (and if relevant, 1/12th of the higher rate band) will be available in the month of payment. Any excess will be taxable at 50%.
 
If, therefore, a taxable payment of £20,000 is made to a former employee, the first £2,916.67 will be taxed at 20%, the next £9,583.33 at 40% and the balance of £7,500 at 50%.
 
Clearly cash flow disadvantages for the taxpayer
This treatment may increase the risk that the PAYE deduction will exceed the ultimate tax liability. If the individual has paid too much tax, the excess can be reclaimed through the end of year tax return, but there are clearly cash flow disadvantages for the taxpayer.
 
The new regulations will apply equally to payments to former employees under employee share plans. If, for example, a former employee exercises an unapproved share option which triggers an income tax liability in respect of the “gain” element, the former employer may need to deduct a larger sum under the new regulations than would have been the case previously.
 
Employers should therefore ensure that their PAYE operators are aware of the new regulations. They may also wish to communicate with employees who are about to leave employment or may recently have done so, and who may have been expecting only a deduction at basic rate from payments due to them on or after 6 April 2011.
 

The “wholly or mainly” in the UK test for EMI replaced by a simple test of whether the company has a permanent establishment
Since the introduction of EMI, one of the eligibility conditions for a company to qualify to grant EMI options has been that its trade had to be carried out “wholly or mainly” in the UK. In many cases, it was not immediately clear whether this test would be satisfied and often a lot of time had to be spent in carrying out the relevant investigations to clarify the issue.   It was therefore greeted with relief in many quarters when the Government announced that, following a ruling by the EU Commission on State aid rules, the “wholly or mainly” test would be replaced by a simple test of whether the company had a permanent establishment in the UK.
 
The calling of the 2010 General Election, however, meant that the legislation was not introduced until the Finance Act (No.3) 2010. The change has effect for options granted on or after 16 December 2010.
 
There is, however, an anomaly, which could easily cause confusion for companies operating EMI.
 
Suppose a company which has a permanent establishment in the UK at all relevant times has granted EMI qualifying options both before and after 16 December 2010. If, after that date, the company ceases to carry on its business wholly or mainly in the UK, the options granted before 16 December 2010 will still be subject to a “disqualifying event” for the purposes of the legislation. The consequence is that, while capital growth up to that point is free from income tax, any future growth in share value will be subject to income tax on exercise, unless the option is exercised within 40 days following the “disqualifying event”. The amendment has no retrospective effect so options granted before 16 December 2010 will still be governed by the pre-existing legislation.
 
Options granted on or after 16 December 2010 will be subject to a “disqualifying event” if the company ceases to have a permanent establishment in the UK.
 
Where a company has granted qualifying options both before and after 16 December 2010, it should continue to consider the application of both tests
Thus, where a company has granted qualifying options both before and after 16 December 2010, it should continue to consider the application of both tests. As indicated above, the “wholly or mainly” test is often the more difficult to apply, but HM Revenue & Customs has confirmed that, at present, its clearance procedure will still be available to assist companies in discharging this burden.