Avoiding a 66% tax liability in the UK The tax authorities in the UK seek, where possible, to tax as income all forms of employment reward whether provided in the form of benefits, equity or salary. The scale and complexity of anti-avoidance legislation in this area is unprecedented. At the same time, the income tax burden on employers and employees has substantially increased with an effective level of tax paid by higher earners equal to 66 percent, taking into account marginal rates, loss of personal allowances and National Insurance Contributions (“NICs”). Accordingly, any opportunity to reduce the tax burden is extremely attractive to both employer and employee.
It is possible to design share plans in the UK in an extremely tax-efficient way, but this planning needs to be done up front. Many international companies have major operations in the UK but few properly consider extending their share plans tax effectively because of misconceptions over the associated cost and complexity. Yet, there is a high cost in not doing this. Unapproved options, performance share plans and most longterm incentive plans are generally taxed on exercise/vesting with the whole of the gain made by the employee subject to income tax and NICs. For an additional rate taxpayer, this means the tax rate is 50 percent. The rate of employers’ NICs is 13.8 percent and the rate of employees’ NICs is 2 percent.
Companies should therefore always consider whether they should introduce share plans that have been designed to meet certain legislative requirements and, in some cases, obtain the approval of HMRC. Under an approved plan, there should normally be no charge to income tax or NICs. Instead, any gain made may be subject to capital gains tax (CGT), which may be taxed at 18 percent or 28 percent (depending on the employee’s marginal rate of income tax). The effect is that it may cost an employer approximately £23,708 to provide a £10,000 net reward to an employee under an unapproved plan, but may only cost £12,195 to provide a net reward of £10,000 to an employee under an approved plan. Employees with entrepreneurs’ relief may be subject to the even lower 10 percent rate of CGT. Employees may also have their annual exemption available, which may fully cover the gain made! Furthermore, the employer may be entitled to a corporate tax deduction on the gains made by the employees.
Where approved plans are inappropriate or unavailable, companies may instead want to consider creating specific arrangements that may still be tax effective. The most common arrangements are joint share ownership plans (JSOPs) or growth share plans (GSPs). These provide for the majority of any gain to be subject to CGT rather than income tax and NICs. However, unlike approved plans, the employer will not be entitled to a corporate tax deduction on gains made by the employees.
Under a JSOP, an employee will acquire an interest in shares jointly with the trustees of an employee benefit trust. Very broadly, the employee will acquire the interest to the future value in the shares; the trustees of the EBT will acquire the residual interest. The market value of the employee’s interest will have some value that will be subject to income tax and NICs but this should be much lower than the value of the shares themselves. Provided that the employee and employer have entered into a joint election to be taxed on the value up front, any gain should be subject to CGT.
For unquoted companies, a similar economic and tax benefit can be achieved by establishing a GSP (essentially a new class of shares that have value on achievement of specific performance conditions or growth).
Disguised Remuneration – Anti-avoidance legislation
Tough new anti-avoidance legislation has been added as Part 7A of the Income Tax (Earnings and Pensions) Act 2003 from 6 April 2011 (with parts applying from 9 December 2010). This legislation has been introduced to allow HMRC to attack arrangements that use (EBTs) and other intermediaries to reward employees in a way that defers or avoids liability to income tax and NICs. The first draft of the legislation was extremely wide and covered most arrangements operated using EBTs. After much lobbying, we have managed to get a number of exclusions so that most forms of share scheme and long-term incentive plans are excluded. However, whilst most direct arrangements between employer or other group company and employee are excluded, companies should generally seek tax advice in respect of all of their share and cash plans. Companies should always seek advice when seeking to use an EBT.