Revised anti-avoidance rules targeting “disguised remuneration” arrangements have been published in the Finance Bill 2011 as well as revised FAQs.
The revised legislation has more than doubled in length and is even more complex than the original draft published in December 2010. Whilst a number of changes have been made which address widespread concerns that normal employee share plan arrangements will be caught by the new rules, a number of uncertainties remain and the earlier optimism that the Revenue were excluding bona fide employee share plans from the scope of the charge has been reduced now that the conditions for this have been published.
The new rules – which can cause income tax and NIC charges to arise where employee benefit trusts (“EBTs”) and other third parties are used to provide remuneration – are scheduled, when the Finance Bill is passed later this summer, to retrospectively come into effect from 6 April 2011.
For further background on the disguised remuneration legislation, please see our previous Law-Nows, details of which are below.
When might the new rules apply?
In broad terms, the new rules will apply if a third party (e.g. an EBT) takes one of the following steps in connection with the provision of a reward or remuneration:
- “earmarking” funds for an employee with a view to a future step being taken – in effect reserving them for the employee without any formal declaration of ownership, which could include shares intended to meet a share award if it vests;
- paying money (including making a loan) or transferring an asset for an employee’s benefit; or
- making an asset available for an employee’s benefit.
In employee share plan terms, it is the earmarking charge that is causing most concerns, although in certain circumstances the other provisions may have an impact on share plans, including the loan provision which could apply where there is cashless exercise of options (see below). Group companies
The legislation requires a third party to take the relevant step. The revised legislation confirms that steps taken by any group company will not normally be caught unless that company is acting as a trustee or there is a tax avoidance motive. In the share schemes context, arrangements which only involve group companies – e.g. if a group company provides a loan to finance an optionholder’s exercise price or the parent company makes the award or issues the shares – should not be caught unless the group company is acting as the trustee of an EBT. However, as most quoted companies use EBTs this is not helpful on its own.
General exclusions for employee share plans
As originally intended, the new rules do not apply to tax favoured share plans, restricted shares, the grant or exercise of a share option (including the grant or vesting of an LTIP) or the issue of new shares. However, the exemptions just cover those actual events – they do not cover ancillary action by EBTs.
Is there earmarking?
Just because an EBT is involved in share plan operation does not of itself cause a charge to arise. “Earmarking” has not been a term used in tax legislation before and so there was understandable confusion about what the term meant. In their revised FAQs the Revenue have said that earmarking requires shares to be allocated in some way to a particular individual. Although an earmarking charge should not apply if hedging of awards by EBTs is on an aggregate basis and shares are not earmarked to named employees it is not clear if an earmarking charge arises if the EBT is fully hedged or assets/money is held specifically with a view to taking a later step which does give rise to a charge. Representations are being made to the Revenue on this point.
If there is earmarking, is there an exemption available?
If there is earmarking, the draft legislation now contains an exemption for share plan awards, but it is very narrowly framed. It only applies where:
- the awards are made by the employer – this is very narrow but it is expected that it will be amended to cover awards granted by a group company and possibly the EBT;
- the awards vest (or the option becomes exercisable) within five years of grant;
- the award will lapse in full if specified conditions (e.g. performance or employment conditions) are not met on or before the vesting date and there is a reasonable chance that none of the award will vest – there remains some uncertainty about these conditions, including the extent to which an employer can exercise a discretion to permit awards to be retained and what a “reasonable chance” means in practice;
- the employee will be subject to income tax on or before vesting or exercise; and
- there is no tax avoidance motive.
Even if a tax charge does not arise on the initial earmarking of shares or cash to individuals, a subsequent earmarking charge may arise if particular circumstances do or do not occur.
What will be noticeable here is that the award has to vest or be exercised within five years, meaning that if companies do need to rely on this exemption, its terms are very restrictive.
Although earmarking is equally applicable to deferred cash awards involving EBTs, similar exemptions to those noted above are available.
Cashless exercise arrangements
Employees now almost universally exercise awards on a cashless basis, directing that the exercise price (along with the tax and NICs arising on exercise) is paid by selling the shares they receive rather than by producing a cheque for the exercise monies up-front.
There had initially been a concern that all cashless exercise arrangements would be caught because the optionholder would be treated as receiving a loan of the exercise price or having an asset transferred to him which he had not (at that point) paid for, even though he paid for it immediately afterwards.
Most cashless exercise arrangements will not now be caught. However, where the EBT makes a loan to fund the exercise price or possibly even where there is no up-front payment direct to the EBT, a tax charge will arise if the exercise price or associated loan is not repaid by the end of the 6th day of the calendar month following the month in which exercise occurred (even if it is subsequently paid). Although short-term settlement is now the general position, in some cases this will be difficult to satisfy practically and will in particular cause problems with takeovers governed by the City Code where payment for the shares fourteen days after acceptance of an offer may cause a tax charge under current drafting. Representations are being made to the Revenue to extend this period and remove the problem in other ways.
Options and awards granted before 6 April 2011 should not be caught by the new rules unless a relevant step is taken on or after 6 April 2011 – for example earmarking or cashless exercise in circumstances which fall outside the exemptions outlined above.
Although the revised legislation addresses a number of issues, a number of concerns and questions remain and further representations are being made to the Revenue.
Going forward companies should review their arrangements for share awards to ensure that, so far as possible, unintended tax charges do not arise. In particular, companies should consider whether they need to make any changes to the arrangements they have with trustees of EBTs and/or their share plans, and in particular for exercises and vestings late in the month.