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August Bulletin – Share Scheme Changes – 1

1. Finance Act 2013 changes

The Finance Act 2013 was given Royal Assent on 17 July 2013. It includes a number of provisions relating to employee share schemes.

Entrepreneurs’ relief on disposal of EMI option shares

An individual who disposes of shares acquired on or after 6 April 2013 upon the exercise of an EMI share option where the option is exercised on or before the tenth anniversary of the date of grant (“relevant EMI shares”) will qualify for the favourable 10% rate of CGT if (assuming he or she would not otherwise qualify):

(a) the shares are disposed of more than one year after the date of grant of the EMI option;

(b) throughout that year the company is a trading company or holding company of a trading group; and

(c) the individual is an officer or employee of the company or, if it is a member of a trading group, of one or more companies within that group.

Shares do not count as “relevant EMI shares” if they are acquired by the exercise of an EMI option more than 90 days after a disqualifying event.

If the company whose shares are acquired ceases to be a trading company or (without continuing to be or becoming a trading company) ceases to be a member of a trading group, the shares will remain “relevant EMI shares” if they are disposed of within 3 years after the date of such cessation.

If the EMI option is exercised after a disqualifying event, that event must have occurred more than one year after the date of grant of the option. If the disqualifying event is a failure to satisfy the “trading activities” test, the period of 3 years last mentioned runs from the end of the 90 day period (if that is later than the cessation date).

Share-for-share exchange following an acquisition of relevant EMI shares

If relevant EMI shares are exchanged for new shares upon a reorganisation to which s126 TCGA 1992 applies (so that the new and old holdings are equated for CGT purposes by virtue of s127) or, subject to what follows, a ‘share-for-share exchange’ (per s135), the new holding of shares will count as “relevant EMI shares”. In the case of a share-for-share exchange, it must be a ‘qualifying exchange of shares’ and, when it occurs, the independence test and the trading activities tests must each be met in relation to the new company.

Identification of shares acquired under an EMI share option

If shares of the same class are acquired on the same day in the same capacity, some of which are relevant EMI shares and some of which are not, the relevant EMI shares and the other shares are each to be separately identified and the relevant EMI shares are to be treated as disposed of only after the remainder of such shares (ss 105(4) and (5) TCGA 1992).

If, within 30 days of a disposal of shares, the person making the disposal acquires shares of the same class, the shares sold are to be identified with shares acquired in that period which are not relevant EMI shares rather than shares acquired within that period which are relevant EMI shares, and subject to that, with shares acquired earlier within that period rather than with shares acquired later within that period. Shares so identified with relevant EMI shares by virtue of these rules are not to be regarded as forming part of an existing s104 holding or as constituting a s104 holding.

These rules have effect, subject to the transitional provisions described below, in relation to disposals of shares on or after 6 April 2013.

Transitional provisions: shares acquired upon exercise of an EMI option between 6 April 2012 and 5 April 2013

If an individual acquires shares upon the exercise of an EMI share option in the tax year 2012-13 and the individual did not dispose of any shares of that class in 2012-13, the shares so acquired are to be treated as ‘relevant EMI shares’ for the purposes of entitlement to ER. If the individual did dispose of shares of that class in that year, he or she may elect for the shares acquired to be treated as ‘relevant EMI shares’. The effect of such an election is that the identification rules described above apply on the basis that the shares disposed of are identified with shares which are not relevant EMI shares, rather than with relevant EMI shares, and with relevant EMI shares acquired at a later time rather than with those acquired at an earlier time. No shares identified with relevant EMI shares under these rules are to be regarded as forming part of an existing s104 holding or as constituting a s104 holding (see para 6, Sched 24 FA 2013). Such an election may not be made or revoked after 31 January 2014. For these purposes, shares are not to be treated as being of the same class unless they are so treated by the practice of a recognised stock exchange or would be if dealt with on a recognised stock exchange.

EMI options: extension, from 40 to 90 days, of the period for tax-free exercise

Tax relief upon the exercise of an EMI share option is not lost following a ‘disqualifying event’ if the option is exercised within a limited period thereafter. This period has been extended, from 40 to 90 days, in relation to disqualifying events occurring on or after 17 July 2013. This change applies to existing EMI options. However, it may nevertheless be necessary, in the case of option contracts or scheme rules which allow exercise within a specified 40-day period (as opposed to “40 days or such other period as may be specified in the EMI Code”) following a ‘disqualifying event’, to amend the terms of the EMI options to reflect this change. Care is needed to avoid a blanket change of all references from “40 days” to “90 days” if, for example, early exercise is also permitted within such a 40-day period, in circumstances other than a “disqualifying event”. A unilateral extension of time for the exercise of an EMI option is, in HMRC’s view, the grant of a fresh right and possibly also itself a ‘disqualifying event’!

Changes to rules governing HMRC approved share plans

The Finance Act makes a number of changes to HMRC approved plans, as first recommended by the Office of Tax Simplification (“OTS”) and accepted by the Government in 2012. In brief, the changes include:

  • SAYE and SIP plans may now include their own definition of when a participant is to be treated as retiring (so as to qualify for favourable tax treatment). The requirement for including a specified age in these and CSOPs is withdrawn. The entitlement of existing SAYE participants who reach a specified age to exercise their options at that time and still qualify for tax relief is, however, protected;
  • The withdrawal of SIP shares, and early exercise of an SAYE option, upon certain cash takeovers of the company will attract favourable tax treatment. In the case of SIP awards, this removes the existing risk of penal clawbacks of tax relief if the company is the subject of an early takeover. Likewise, there is no income tax liability if a CSOP option is exercised before the third anniversary of grant upon certain cash takeovers;
  • The limit on tax-free reinvestment of dividends on SIP shares has been removed, leaving the company to specify its own limit (if any);
  • The ‘material interest test’ (which denies participation to employees holding substantial interests) has been abolished in relation to SIPs and SAYE option schemes. In the case of CSOPs, the threshold level of interest has been raised from 25 to 30% to align it with the corresponding threshold level in relation to EMI share options;
  • The use of ‘restricted shares’ is now permitted under HMRC approved schemes but, when valuing shares for the purposes of individual limits, shares subject to restrictions are to be valued as if they are not restricted. These changes allow private companies, for example, to use shares which are subject to employee pre-emption provisions and other restrictions on transfer. However, details of any ‘restrictions’ must be given to participants (albeit only after the option has been granted or, in the case of a SIP, the shares have been awarded);
  • Changes have been made to the rules relating to the acquisition of ‘Partnership Shares’ under a SIP out of deductions from salary over an ‘accumulation period’. The number of shares acquired may now be determined by reference to the market value at either the start or end of the accumulation period. This removes an existing ‘trap’ which arose if the market value of a share rose or fell over the accumulation period;
  • 7-year savings contracts linked to new SAYE share options cannot be entered into on or after 23 July 2013;
  • The entitlement of existing SAYE participants who reach a specified age to exercise their option at that time and still qualify for tax relief does not apply to options granted on or after 17 July 2013.

Most of these changes will have effect from 17 July 2013, although the removal of the limit on reinvestment of cash dividends paid on SIP shares is backdated to 6 April 2013.

For the most part, existing schemes are to be interpreted as if the changes were deemed to be made, but care must be taken, particularly in relation to provisions allowing for early exercise upon certain takeovers. New schemes must specifically include provisions which allow for the exercise of SAYE and CSOP options in such defined takeover situations.

“Employee shareholder” status – George Osborne’s idea

Notwithstanding the fact that it was at one stage thrown out by the House of Lords (shortly after the Chancellor delivered his 2013 Budget!), the legislation implementing the idea first promoted by George Osborne, at a speech to a Conservative Party conference in Birmingham in 2012, has survived its journey through Parliament.

The rules governing the new status of “employee shareholder” are in section 205A of the Employment Rights Act 1996 (as amended by the Growth and Infrastructure Act 2013). The associated reliefs and exemptions from income tax and CGT are to be found in section 55 and Schedule 23, Finance Act 2013. The new rules do not take effect until a date specified in regulations made by the Secretary of State, expected to be 1 September 2013.

It remains unclear whether the agreement by an employee to become an “employee shareholder” in consideration for the issue by the employer company, or its parent undertaking, of fully-paid shares with an actual market value (i.e. ignoring the effect of any s431 election) of at least £2,000, is a sufficient ‘payment’ to the company of the nominal value of the shares. It is not a payment in cash, nor an undertaking to do work or perform services, nor would it appear to be ‘money’s worth’, and therefore, having regard to ss 582-587 Companies Act 2006, except in the case of a subsidiary employer paying the nominal amount to an issuing parent undertaking, it would appear to require regulations to be made (under s583(4) CA 2006) providing for the employee’s agreement to be regarded as a credit equivalent to a payment in cash.

Changes made in the passage of the legislation provide that the employee must be given a written statement giving particulars of the status and specified details of the rights and restrictions attaching to the shares. The individual must be an employee, not merely a (non-executive) director – although it appears not to matter that he or she later ceases to hold employment, but keeps the shares! The agreement to become an employee shareholder is of no effect unless, having been given the statement, the employee receives advice from a “relevant independent adviser” (which is defined to include, amongst others, a qualified lawyer), and a 7-day ‘cooling-off’ period has elapsed. The costs of such advice are to be met by the employer company. This benefit is exempt from income tax (per s326B ITEPA). Regulations are expected to be made specifying the terms which any agreement for a buyback by a company (but not an individual or non-corporate trustee) of the employee’s shares if the employee leaves, or wishes to sell the shares, must meet.

For income tax purposes, the employee is to be deemed to have made a payment of £2,000 for the acquisition of the shares unless the employee (and/or a connected individual) has, or had within the year before the acquisition a material (25%) interest in the employer company or any parent undertaking (not only the issuer), and such person or persons have no rights to acquire such an interest and there are no arrangements in place which would enable them to do so (“the material interest test”). For these purposes, a material interest relates to the voting rights held or, if the company in question is a close company, rights to any distribution, whether on a winding-up or otherwise. Insofar as the actual (or, if a s431 election is made, the unrestricted) market value of the shares exceeds £2,000, the normal rules apply to impose a charge to income tax, on acquisition of the shares, on the amount of the excess. The drafting of para 14 of Schedule 23 FA 2013 envisages the possibility that such shares might be acquired upon the exercise of a nil-cost EMI share option. However, as the value of the shares acquired upon exercise is not normally predictable, it is difficult to envisage how the acquisition of “employee shareholder” shares pursuant to an EMI, or any option, would work. The shares would normally be issued otherwise than pursuant to any other pre-existing ‘right to acquire’ them. The shares can be convertible (see further below) and, if they are, s437 (tax relief on acquisition of convertible shares) is to be ignored for the purposes of determining the actual market value of the shares acquired.

A new s385A in Chapter 3, Part 4 of ITTOIA 2005 affords an exemption from income tax on an amount paid for the purchase of such employee shareholder shares from an individual who has ceased to hold office and employment with the employer company and any associated company, notwithstanding that (inter alia) the shares have not been held for five years (as would normally be required to avoid the payment being taxed as a distribution). Regrettably, such relief is not extended to buy-backs of other shares from ex-employees, notwithstanding the recent changes to the Companies Act to facilitate the buy-back of shares into treasury by a private company for the purposes of an employees’ share scheme.

The principal attraction of the new status lies in the exemption from capital gains tax on a disposal of the employee shareholder shares, available only if the unrestricted market value of the shares did not exceed £50,000, and the material interest test was satisfied, at the time of acquisition of the shares. The base cost of the shares includes the £2,000 deemed, but untaxed, payment. It matters not when the employee shareholder shares are disposed of (it may be during or after the employment). It should be noted that the provisions of s127 TCGA 1992 (reorganisation of share capital), as applied by ss 135 and 136, do not apply to such employee shareholder shares (per s236F TCGA 1992). For the purposes of identifying shares disposed of, employee shareholder shares are to be separately pooled and the normal identification rules are disapplied. If an employee holds shares of the same class but some only are employee shareholder shares, he or she may determine, when disposing of some only of the total holding, what proportion of the shares disposed of are to be exempt and the consideration received is to be apportioned accordingly (s236E TCGA 1992).

The normal rules regarding relief from corporation tax for employee share acquisitions apply, and a deduction is allowed for the £2,000 deemed to have been given for the acquisition of the employee shareholder shares.

How will the new rules be used?

In practice, the fact that employee shareholder shares can be in a subsidiary is likely to be of attraction to the directors and managers of companies under the control of a private equity fund as they are otherwise barred from granting EMI share options or using HMRC approved schemes. It is anticipated that the mechanism likely to be adopted by the private-equity industry and its advisers will involve the issue of shares which, in default of the occurrence of certain targets being met, will convert into shares with an entitlement on winding-up (etc.) to a preferential distribution of at least £2,000.

Exemption threshold for employment-related ‘taxable cheap loans’ and ‘notional loans’ arising upon the acquisition of employment-related securities at an undervalue

The limit, of £5,000, on the amount of a ‘taxable cheap loan’ (and a ‘notional loan’ arising upon the acquisition of employment-related securities at an undervalue) which is exempt from being a taxable, and reportable, benefit, is raised to £10,000 with effect from 6 April 2014. This makes more attractive to smaller companies the idea of inviting employees to subscribe for newly-issued shares (or following implementation of company law changes to reflect proposals made in the Nuttall Review, shares out of treasury) on the basis that the employee agrees to pay full market value for the shares, but the consideration is left outstanding or is to be satisfied on a deferred payment basis out of salary deductions. It is important to note that deferred payment for the purchase of shares from an employees’ trust will attract an immediate and penal charge to income tax and NICs under the ‘disguised remuneration’ rules. It follows that such arrangements should use only shares issued by the employer company or another member of the same 51% group. If under such an arrangement the employee acquires shares with a market value of less than £10,000, there will be no annual charge to income tax on the benefit of either an actual loan by the employer to fund the acquisition of such shares or, if the agreed consideration is left outstanding, a notional loan. It is important to note that a loan to an employee by any person other than the employer company or another member of the same 51% group will also give rise to an immediate penal charge to income tax and NICs under the ‘disguised remuneration’ rules. Care should be taken, as the exempt threshold applies to the aggregate of outstanding balances on all such loans to an employee.

Introduction of a general anti-abuse rule

The GAAR applies to abusive tax arrangements entered into on or after 17 July 2013. The GAAR as first published was revised following consultation. It provides for the counteraction of tax advantages that are abusive on a just and reasonable basis, and may take a number of forms appropriate to the particular tax in question. The taxes covered are income tax, NICs, corporation tax, CGT, inheritance tax, petroleum revenue tax, stamp duty land tax and the proposed annual tax on ‘enveloped dwellings’. Counteraction must first be notified by a designated HMRC officer and unless, after consideration of taxpayer representations, that officer decides that it ought not to apply, the arrangements must be referred to an advisory panel, to be established by the Commissioners for HMRC, for its opinion(s).

In addition, the Government is to consult on new proposals to target the promoters of tax avoidance schemes, the intention being to tackle both the supply of and demand for such schemes. The proposals are to include the ‘naming and shaming’ of promoters.

Restriction of corporation tax relief for employee share acquisitions

CT relief is now available in relation to employee share acquisitions only to the extent that it is expressly provided for in the Corporation Tax Act 2009 (as amended). This is intended to rule out relief under general rules for certain accounting charges associated with such employee share acquisitions – as certain well-known firms of accountants have been encouraging companies to claim. Further, in the case of employee share options, no relief is now allowed unless the shares are in fact acquired pursuant to the option. This does not disallow a CT deduction for any amount of a cash cancellation payment which is taxed as earnings of the employee but will, for example, mean that no relief is available under the CTA 2009 rules if the option shares are not in fact acquired by reason of the option lapsing or being cancelled or released pursuant to any arrangements. These restrictions take effect in relation to any accounting period ending on or after 20 March 2013 but do not apply to a deduction for an accounting period beginning before 20 March 2013 but ending on or after that date if the acquisition of shares occurs before that date. Likewise, in the case of a share option, the restriction does not disallow a deduction for an accounting period beginning before that date but ending on or after that date, if the option was granted before 20 March 2013 and the shares cannot be acquired pursuant to the option because it lapsed or was cancelled before that date.

The changes made do not disallow deductions for:

  • expenses incurred in setting up or administering the scheme
  • the cost of borrowing for the purposes of the scheme; or
  • fees, commission, stamp duty, SDRT and similar incidental expenses of acquiring the shares.

Close company loans to participators

It had been hoped that the Government would take heed of the pitfalls for close companies in making loans to employees and employees’ share trusts, where a penal charge to tax arises under s455 if the loan is made to an actual or deemed participator in the company. As yet, there is no mention of the prospect of such relief. Indeed, changes taking effect from 20 March 2013:

  • charge close companies on loans and other payments they make via ‘intermediaries’ to their participators; and
  • update the repayment rules with an anti-avoidance provision.

It is understood that the arrangements targeted involve the making of loans and other payments to participators in a close company via intermediaries such as LLPs, partnerships and trusts in which the close company and at least one participator are members, partners or trustees. The new provisions are likely to catch many situations in which, for example, a first-time loan is made by a close company to an employees’ trust to fund the acquisition of shares (by subscription or purchase). Until now, if the trust did not already hold shares or options to acquire shares, such a loan has generally been considered outside the scope of s455. Now, if any member of the class of beneficiaries is a shareholder, a loan to the trust will be caught even if the trust itself has no shares or right to acquire shares. There is to be an exception to the charge for certain trustees, but until the legislation is published, the scope of the changes remains unclear. Other arrangements targeted include the repayment of a loan before the end of the 9-month period provided for in s455, followed shortly by an advance of a new loan on similar terms.