Welcome to our Employee Incentives Update, we hope you find it useful.  This Update contains a round-up of recent key developments in remuneration. 

In summary:

ENTERPRISE MANAGEMENT INCENTIVES (EMI)

  • The tax reliefs for EMI options granted on or after 7 April 2018 may be withdrawn due to a failure to renew EU state aid approval of EMI

TAXATION OF TERMINATION PAYMENTS

  • A new concept of taxable Post-Employment Notice Pay has been introduced which applies to termination payments made to employees whose employment terminates on or after 6 April 2018

In full:

ENTERPRISE MANAGEMENT INCENTIVES (EMI)

Why do EMI options require EU State Aid approval?

HM Treasury has failed to secure the renewal of EU State Aid approval necessary under EU law to enable EMI options granted after 6 April 2018 to continue to benefit from tax advantages.  EMI requires EU State Aid approval as, unlike the other HMRC tax-advantaged plans, EMI options can only be granted by companies with certain business activities which means they are caught by the State Aid rules.  State Aid is generally unlawful under the EU treaties, unless it clearly falls within a specific exception.  Where State Aid approval is given by the EU, it is time limited and must be renewed from time-to-time. 

Whilst HM Treasury still appears optimistic that EU State Aid approval will be given in due course (although no revised timetable for this is forthcoming), it is unclear whether it will be retrospective in respect of options granted from 7 April 2018 and/or whether it will be subject to amendments to the current EMI legislation.

How does this affect EMI options granted on or before 6 April 2018?

This failure to secure renewal of the State Aid approval does not affect EMI options granted on or before 6 April 2018 as HMRC considers that the State Aid approval applies to the granting (and not the exercise) of share options. 

How does this affect EMI options granted on or after 7 April 2018?

HMRC's view is that "EMI share options granted in the period from 7 April 2018 until EU State Aid approval is received may not be eligible for the tax advantages presently afforded to option holders, and accordingly share options granted in that period as EMI share options may necessarily fall to be treated as non-tax advantaged employment-related securities options".

What should companies do now?

HMRC is encouraging companies to delay granting new EMI options until the EU reaches a decision on renewing State Aid approval.  However, this may not be feasible: 

  • where a company is expecting that the value of its shares is likely to increase significantly in the next few months. In that case it may prefer to grant EMI options while they may still be able to agree a lower actual market value of the option shares with HMRC and take the risk that they may ultimately prove to be taxed as non-tax advantaged options.  HMRC has confirmed that its Shares and Assets Valuation Division will continue to approve share valuations for EMI purposes on a "business as usual basis"; and
  • where a company expects that it will no longer qualify for EMI purposes in the coming months.  For example, this may be where the workforce is likely to increase to 250 or more full-time employees or the gross assets limit of £30 million is likely to be exceeded. Again, the company may want to take the risk that they may ultimately prove to be taxed as non-tax advantaged options.

If EMI options are granted before the renewed EU State Aid approval is obtained, it may be prudent to include a clause in the new EMI documentation which permits amendments to the EMI share option if and once the approval is obtained.   In addition, option holders entering into an EMI agreement during this time should be made aware of the current uncertainty around the tax treatment and the risk that the option may ultimately be taxed as a non-tax advantaged option.

TAXATION OF TERMINATION PAYMENTS

Post-Employment Notice Pay

The tax regime in respect of payments paid in connection with the termination of employment (sections 401 and 403 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)) was amended on 6 April 2018. 

Whilst the £30,000 tax-free threshold has been retained, the types of payments that fall within the threshold have changed.  New section 402D ITEPA 2003 introduces a concept of "post-employment notice pay" (PENP). In essence, PENP is the basic pay equivalent for any unworked notice period calculated using a specified formula.

Where an individual is not employed for the full notice period, any "relevant termination award" made post-termination will be taxed as general earnings (and therefore subject to income tax and Class 1 employer's and employee's NI) in so far as it is equal to (or less than) the PENP. 

We have produced a comprehensive booklet outlining the changes and giving worked examples of how the PENP formula should be applied in a number of different scenarios.

A copy of the booklet can be found here: https://www.addleshawgoddard.com/globalassets/insights/employment/tax-on-termination-payments.pdf

In addition, our Top Ten Tips for navigating the new tax regime are set out below.

Top Ten Tips

1          If you are only paying a contractual PILON there is no need to run the PENP calculation.

2          If you are only paying a contractual PILON and/or a statutory redundancy payment there is no need to run the PENP calculation.

3          If you are paying a contractual PILON and any other compensation amount (including any enhanced redundancy payment) you should run the PENP calculation.  The amount "T" in the formula will be the amount of the contractual PILON payment already taxed.

4          You must use the simplified calculation (where "P" = 1 etc.) if (i) the pay period is a month, and (ii) the minimum contractual notice is expressed in a whole number of months, and (iii) no notice is worked or some notice worked and the post-employment notice period is a whole number of months. 

5          If a fixed or limited term contract comes to an end and any termination payment is made, you must run the PENP calculation.

6          If a payment is subsequently made to an employee whose employment is terminated where the employer was legally able to terminate the employment contract without notice, you must still run the PENP calculation.

7          Where a termination payment is made after 6 April 2018 but the termination date was before 6 April 2018, the new rules will not apply.

8          The PENP position is complicated where an employer makes both (i) contingent monthly        contractual PILON payments to an ex-employee which cease (or reduce) if s/he gets a new job and (ii) an additional compensation payment.   We are hoping for some HMRC guidance on this but in the meantime we have produced a separate note to explain how we believe this will work in practice.  Please let us know if this situation applies to you.

9          Compensation for unfair dismissal awarded by a tribunal or under a settlement agreement is taxable to the extent that it represents PENP.

10         If you don't currently include PILON clauses in your standard employment contracts, now is the time to consider amending your standard form for future employees as there will no longer be any tax advantage of not including such a provision.