Share scheme legislation to become more complex
The Finance Bill published on 31 March 2011 will introduce measures to combat the perceived use of third party arrangements, typically employee benefit trusts (EBTs), to avoid, reduce or defer tax liabilities on rewards from employment or to avoid restrictions on pension tax relief (by the use of an employer-funded retirement benefits scheme or EFRBS). The latest version contains some adjustments to the original proposals (the draft legislation has more than doubled in length to 59 pages), however the essential structure remains the same.
Legislation has effect from 6 April 2011
Broadly, under the legislation, an income tax charge will arise when, at any time on or after 6 April 2011, a third party takes a “relevant step” by making a payment or transferring or otherwise making available property (“earmarking”) 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. Although the legislation is not yet in final form (and there may be changes resulting from lobbying by interested bodies), it has effect where a “relevant step” is taken on or after 6 April 2011.
This means, to take just one example, that a loan from a third party (rather than direct from the employer) will be charged to income tax when made, rather than only if and when written off, as currently. Furthermore, the charge will be on the full value, not just on the “benefit” element. Thus, tax will arise at the outset on the full value of an interest-free loan of £10,000 rather than on the interest-free benefit of £400 calculated at the “official rate” of interest (4% of £10,000). Tax charges on benefits do not fall away on cessation of employment, as has typically occurred in the past, and no relief is given for tax paid on a loan if the loan is repaid.
Loans are just one example of “earmarking”.
There are, however, specific “safe harbour” exemptions for:
- tax-favoured employee share and share option plans and registered pension schemes
- certain types of performance share plans, exit-only phantom share awards and “earmarking” of shares to satisfy share options
- group transactions, so that, for example, ordinary remuneration paid by a third party (such as a group service company) rather than the employer direct is not affected as long as the arrangements are not designed to avoid tax
- deferred remuneration arrangements if (a) receipt is subject to conditions so that there is a possibility that the employee will not receive the benefit of the award (b) the award must vest date within 5 years of grant and (c) the award must be taxable as employment income
- car ownership schemes and certain types of short-term loans, such as loans made for the “cashless exercise” of share options.
The “safe harbour” exemptions are, however, drawn very restrictively and the way in which existing arrangements currently operate might not satisfy the relevant conditions. Looking at how this could affect employee share plans, this might mean that amendments will have to be made to the terms of existing plan rules. For example, the exemption for performance share plans only applies where early vesting is permitted solely on death. Many plans permit early vesting on termination of employment for reasons of ill-health or redundancy, or on a change in control of the company, but these provisions would prevent such plans from falling within the exemption.
Further, for the purpose of certain exemptions, the number of “earmarked” shares held by the EBT must not exceed the number “which might reasonably be expected to be needed for meeting the award”. It is not entirely clear how this is to be tested.
In addition, “anti-forestalling” provisions apply to the payment of sums (including loans) between 9 December 2010 and 5 April 2011. A tax charge will arise under these provisions if the sums have not been repaid before 6 April 2012 (or have not otherwise been charged to tax).
In summary, this area of the law is becoming more complex (particularly in relation to deferred remuneration) and, until the new legislation has been tested, less certain. Technical advice will often be required which will typically depend on the precise circumstances of each individual case.
Companies which operate straightforward employee share schemes without EBT or other third party involvement and which grant rights over new shares rather than existing shares should have no cause for concern.
Employees could incur a tax liability where they have received no tangible benefit
Companies which operate arrangements which involve any form of EBT or other third party should review these in the light of the new legislation, as it contains a number of potential traps which in some cases could result in employees incurring a tax liability where they have received no tangible benefit. EBTs continue to be appropriate, and even necessary, in many employee share plans, and tax complexity should not distract companies from their commercial objectives, but they need to proceed with caution. Since the legislation has effect from 6 April 2011, companies should consider the possibility of a disguised remuneration charge before taking any action which might be considered a “relevant step”.