Employment-Related Securities and Unlisted Companies

This book has needed writing since the current rules on employment-related securities were introduced in Finance Act 2003. Other works deal with tax-advantaged share and share option schemes but such schemes are typically of interest to the larger company. This book is written with unlisted, mainly private companies in mind and so, with one exception, deals with employee share acquisitions which do not benefit from any special tax advantages. The exception is the Enterprise Management Incentives (EMI) share option scheme, which is mainly for unlisted companies and so is covered in this book.

The vast majority of companies registered at Companies House are owner-managed private companies. The employment-related securities (ERS) regime applies to all shares owned by directors or employees in the company or group they work for with few exceptions. This book is of importance therefore for all shareholder-directors and employees of such companies, and for their professional advisers.

Often the tax implications of the ERS rules are not onerous, but sometimes result in an income tax charge for the employee, and the company may also be obliged to pay PAYE and National Insurance Contributions.

It has been the case for many years that if a director or employee acquires shares free or for less than they are worth, they are liable to income tax on the difference. This book explains how the rules for taxing such share awards work, including the rules for non-HMRC approved share options and for options qualifying under EMI. There are also chapters dealing with capital gains tax aspects of shares and share options, the PAYE and national insurance implications and the corporation tax deduction which may be claimed by the company.

Form 42 giving details of employee share acquisitions can be a perennial headache for companies and their advisers. This book explains in detail what the entries mean and how to complete these.

There is no other publication of its type which deals with the ERS rules in depth and, as explained, this is a subject which all company owner-managers and their advisers need to be informed about.

Contents

 

Contents. iii

Abbreviations. xiii

Tables of authorities. xv

1.            Summary and overview.. 1

1.1.    Introduction.. 1

1.2.    Why do you need this book?. 2

1.3.    Four ways for employees to acquire shares. 2

1.4.    Typical situations. 3

1.5.    Other situations. 4

1.5.1.          ‘Alphabet’ shares etc. 4

1.5.2.          Commercial expediency. 5

1.5.3.          ‘Phantom’ options. 6

1.5.4.          Where sale of the company is in prospect 6

1.5.5.          The employee’s perspective. 7

1.5.6.          Other ‘exit’ routes. 8

1.5.7.          ‘Fair’ value. 9

1.5.8.          A less conventional exit?. 9

1.5.9.          Conclusion.. 10

1.6.    The charge on acquisition.. 10

1.7.    Restricted securities – Chapter 2. 10

1.7.1.          Meaning of ‘restricted’ 10

1.7.2.          Market value. 11

1.7.3.          Personal and other restrictions. 12

1.7.4.          HMRC practice etc. 12

1.7.5.          Elections. 13

1.7.6.          Managers’ equity investments. 14

1.8.    Securities acquired for less than market value – Chapter 3C.. 14

1.9.    Securities disposed of for more than market value – Chapter 3D......... 15

1.10. Post acquisition benefits – Chapter 4. 16

1.11. Securities options – Chapter 5. 17

1.12. Some suggestions. 18

2.            Introduction to the legislation & miscellaneous. 21

2.1.    Introduction.. 21

2.2.    Terminology. 21

2.3.    FAQs and the Employment Related Securities Manual 22

2.4.    Structure of the legislation.. 22

2.5.    Tax charges on acquisition.. 23

2.5.1.          General rule. 23

2.5.2.          Money’s worth.. 24

2.5.3.          Earnings and benefits. 25

2.5.4.          General earnings and specific employment income. 26

2.5.5.          Compliance. 26

2.6.    Readily convertible assets. 27

2.7.    The corporation tax deduction – overview... 28

2.8.    History and commencement of the legislation.. 29

2.9.    Finance (No.2) Act 2005 and tax avoidance. 30

2.9.1.          Finance Act 2006. 31

2.9.2.          From 2006 to the present 32

2.10. Requests for HMRC interpretation.. 32

3.            Definitions. 35

3.1.    Introduction.. 35

3.2.    Scope of the legislation.. 36

3.3.    Negative amounts. 37

3.4.    Meaning of securities. 38

3.4.1.          Legislation.. 38

3.4.2.          Gilts. 39

3.4.3.          Partnership ‘shares’ 39

3.4.4.          Certificates etc. 40

3.4.5.          Options. 40

3.4.6.          Warrants to subscribe. 40

3.4.7.          Insurance contracts. 41

3.4.8.          Collective investment schemes etc. 41

3.4.9.          Amendment of definition of ‘securities’ by Treasury Order  42

3.5.    Definition of market value. 42

3.6.    Consideration.. 45

3.7.    What shares are employment-related?. 46

3.7.1.          An objection.. 46

3.7.2.          By reason of employment 47

3.7.3.          The deeming provision.. 48

3.7.4.          HMRC’s view... 49

3.7.5.          A tentative solution.. 50

3.7.6.          Further guidance would be welcome. 51

3.7.7.          Further meanings. 51

3.7.8.          Former or prospective employment 52

3.7.9.          Made available …... 53

3.7.10.        … by the employer or by a person connected with the employer  54

3.7.11.        Time of acquisition.. 56

3.7.12.        The exception for shares acquired through family or personal relationships  56

3.7.13.        Scope of the exception.. 57

3.7.14.        No corporation tax deduction.. 60

3.7.15.        Non-family members. 60

3.7.16.        Interaction of section 421B(3)(b) and section 62. 62

3.8.    Bonus issues & replacement securities. 64

3.9.    Rights issues. 65

3.10. Associated persons. 65

3.11. International aspects. 66

3.11.1.        Exclusions: residence etc. 66

3.11.2.        Internationally mobile employees. 66

3.12. Exclusions: public offers. 67

3.13. Exclusions: HMRC-approved schemes. 68

3.14. Employee-controlled companies. 68

3.15. Duty to provide information – Form 42. 69

3.16. Reportable events. 69

3.17. Responsible persons. 69

4.            Reporting requirements: Form 42. 71

4.1.    Duty to provide information.. 71

4.1.1.          Introduction.. 71

4.1.2.          Statutory obligation.. 71

4.1.3.          Responsible person.. 72

4.1.4.          Some practical points. 72

4.2.    Reportable events. 73

4.2.1.          Reportable v chargeable events. 73

4.2.2.          List of reportable events. 73

4.3.    By reason of employment 74

4.3.1.          Securities deemed to be acquired by reason of employment 74

4.3.2.          Connected person & control 75

4.3.3.          The exception.. 75

4.4.    Occasions when no report is required.. 76

4.5.    HMRC guidance on completion of Form 42. 76

4.6.    Form 42 itself 76

4.7.    ‘Founders’ shares. 78

4.8.    Grant or exercise of share options – Form 42 Section 1. 79

4.8.1.          Section 1a – grant of securities options. 79

4.8.2.          Section 1b – acquisition of securities in connection with securities options  80

4.8.3.          Section 1c – assignment and release of securities options. 82

4.9.    Acquisition of securities – Form 42 Section 2. 82

4.9.1.          Restricted and unrestricted securities – basic concepts. 82

4.9.2.          Acquisition of unrestricted shares – Type A.. 83

4.9.3.          Acquisition of restricted shares – Types B, C and D.. 83

4.9.4.          Elections. 84

4.9.5.          Election under section 431(1) to ignore all restrictions. 85

4.9.6.          Election under section 431(2) to ignore specified restrictions  86

4.9.7.          Election under section 425. 86

4.9.8.          Acquisition of convertible shares - Type E.. 87

4.9.9.          Other acquisitions – Types F and G.. 87

4.10. Events occurring after acquisition of securities – Form  42  Section 3.... 88

4.10.1.        General 88

4.10.2.        Restricted securities – Section 3a. 88

4.10.3.        Variation of restrictions for shares acquired before 16 April 2003 – Section 3b  89

4.10.4.        Conversion of securities on or after 6 April 2005 – Section 3c  89

4.10.5.        Discharge of notional loan – Section 3d.. 90

4.10.6.        Receipt of other benefits from securities – Section 3e. 90

4.10.7.        Securities sold for more than market value – Section 3.f 91

4.10.8.        Artificial enhancement of market value – Section 3g. 92

4.11. Participating companies – Form 42 Section 4. 92

4.12. Nil return - Form 42 Section 5. 93

4.13. Declaration – Form 42 Section 6. 93

4.14. Penalties    93

5.            Restricted Securities. 95

5.1.    Introduction and overview... 95

5.1.1.          Background and history. 95

5.1.2.          Election to pay tax ‘up-front’ 96

5.1.3.          Use of terms: ‘restriction’ and ‘market value’ 97

5.2.    What are restricted securities?. 99

5.2.1.          Significance. 99

5.2.2.          Definition.. 99

5.2.3.          Transfer, reversion or forfeiture. 100

5.2.4.          Restriction on freedom to dispose & other rights. 100

5.2.5.          Disadvantage. 100

5.2.6.          Effect of restrictions on market value. 101

5.2.7.          Transfer restrictions. 103

5.2.8.          UBS AG v HMRC.. 104

5.3.    Shares accepted as unrestricted – HMRC guidance. 107

5.4.    Statutory exclusions. 108

5.5.    Pre-emption rights and ‘good’ and ‘bad’ leavers. 108

5.6.    Shares and Assets Valuation practice. 110

5.6.1.          The share valuation manual 110

5.7.    Restricted and unrestricted values AMV/UMV.. 111

5.8.    No charge on acquisition in certain cases. 112

5.9.    Chargeable events and amounts chargeable. 114

5.9.1.          Chargeable events. 114

5.9.2.          Further commentary on the formula. 116

5.10. Observations. 118

5.11. Exclusion for certain control situations. 119

5.12. Elections to opt out of Chapter 2. 119

5.12.1.        Section 431. 119

5.12.2.        New company. 120

5.12.3.        Established company. 121

5.12.4.        Where shares are forfeited.. 122

5.12.5.        To elect or not to elect?. 122

5.12.6.        Partial elections – not generally understood?. 122

5.12.7.        Some further examples. 123

5.13. Election on occurrence of a chargeable event 125

5.14. Pro forma elections. 126

5.15. Shares acquired under HMRC approved plans. 126

5.16. Avoidance cases – section 431B.. 126

6.            Convertible securities. 129

6.1.    Introduction.. 129

6.2.    Convertible securities. 129

6.3.    Adjustment of charge. 130

6.4.    Chargeable events. 131

6.5.    Amount of charge. 131

6.6.    Amount of gain.. 132

6.7.    Consideration given for a right to convert 133

6.8.    Case outside section 438 charge. 134

6.9.    NICs election.. 134

6.10. Interaction with other chapters of Part 7. 134

7.            Securities with artificially depressed or enhanced market value & other tax charges  137

7.1.    Securities with artificially depressed market value. 137

7.1.1.          The ‘mischief’ targeted.. 137

7.1.2.          Application of Chapter 3A.. 138

7.1.3.          Charge on acquisition.. 138

7.1.4.          Amount of charge. 138

7.1.5.          Restricted and convertible securities. 139

7.2.    Other tax charges. 139

7.2.1.          Restricted securities. 139

7.2.2.          Conditional interests in shares. 141

7.2.3.          Convertible securities. 142

7.2.4.          Adjustment of market value: charge on conversion.. 142

7.2.5.          Adjustment of consideration or benefit received.. 142

7.2.6.          Disapplication of certain exceptions from charges. 143

7.3.    Securities with artificially increased market value. 143

7.3.1.          Introduction.. 143

7.3.2.          Application of Chapter 3B.. 144

7.3.3.          Charge on non-commercial increases. 144

7.3.4.          Securities subject to restriction on the valuation date. 144

7.3.5.          Securities subject to restriction during the relevant period.. 145

8.            Securities acquired for less than market value. 147

8.1.    Introduction.. 147

8.2.    Loans to participators. 148

8.3.    Application of Chapter 3C.. 148

8.4.    Cases which are outside Chapter 3C.. 149

8.5.    Notional loan.. 150

8.6.    Amount of notional loan.. 151

8.7.    Discharge of notional loan.. 151

8.8.    The nil paid share scheme. 152

8.9.    The section 455 argument 153

9.            Securities disposed of for more than market value. 155

9.1.    Introduction.. 155

9.2.    When Chapter 3D applies. 155

9.3.    Amount chargeable. 155

9.4.    Fair market value. 156

9.5.    Gray’s Timber. 157

9.6.    Details of the case. 158

9.7.    Special Commissioner’s decision.. 159

9.8.    The Courts’ rulings. 159

9.9.    Author’s comments. 161

9.10. Earn-outs    162

10.         Post-acquisition benefits from securities. 165

10.1. Introduction.. 165

10.2. The charge  166

10.3. Impact of Finance (No 2) Act 2005 changes. 166

10.4. Payment of dividends. 169

10.5. Application of the ‘sham’ principle. 171

10.6. Case law precedent?. 171

10.7. Technical objections to taxation of dividends as earnings. 172

10.8. PA Holdings. 173

10.9. Effect of PA Holdings decision.. 174

10.10.                   Application of PA Holdings decision to Chapter 4. 176

10.11.                   ‘Alphabet’ shares. 176

10.12.                   A double charge to tax?. 181

10.13.                   Whether ‘something has been done’ 182

10.14.                   A question of earnings. 184

10.15.                   Other Chapter 4 situations. 184

10.16.                   Summary. 185

11.         University spin-out companies. 187

11.1. Introduction.. 187

11.2. Application of Chapter 4A.. 188

11.3. Tax relief on acquisition.. 188

11.4. Tax relief following acquisition.. 188

11.5. Scope of relief 189

11.6. Disapplication of Chapters 2 and 3B.. 189

11.6.1.        Restricted securities. 189

11.6.2.        Disapplication of Chapter 3B.. 190

11.7. Definitions  190

11.8. Capital gains tax. 191

12.         Securities options. 193

12.1. Introduction.. 193

12.2. Commencement 194

12.3. Chargeable events. 194

12.4. Amount of charge. 195

12.5. Deductible amounts. 196

12.6. Employer’s NIC paid by employee. 196

12.7. Exchange of options. 197

12.8. Earn-outs    197

12.9. Interaction with other chapters of Part 7. 197

13.         Enterprise management incentives. 199

13.1. Introduction & overview... 199

13.2. Key advantages. 199

13.3. No approval required.. 201

13.4. Requirements. 201

13.5. Capital gains tax. 201

13.6. The EMI ‘Code’ 203

13.7. Market value. 204

13.8. Option price is market value. 205

13.9. Option price is less than market value. 205

13.10.                   Tax charge following a disqualifying event 206

13.11.                   Disqualifying events. 207

13.11.1.      Company. 208

13.11.2.      Employee. 209

13.11.3.      Variation of terms etc. 209

13.11.4.      Other disqualifying events. 209

13.11.5.      Legal aspects. 210

13.11.6.      Case law... 211

13.11.7.      Exception for certain conversions. 212

13.12.                   Section 431 elections. 212

13.12.1.      Deemed election.. 212

13.12.2.      HMRC guidance. 213

13.12.3.      Tax avoidance. 216

13.13.                   Seeking ‘comfort’ in advance. 217

13.14.                   Corporation tax deduction.. 217

13.15.                   Schedule 5 requirements: qualifying options. 218

13.15.1.      General requirements. 218

13.15.2.      Purpose. 218

13.15.3.      Maximum entitlement 218

13.15.4.      Three year restriction period.. 220

13.15.5.      Maximum value of options over relevant company’s shares  220

13.15.6.      Qualifying companies. 220

13.15.7.      Control 220

13.15.8.      Qualifying subsidiaries. 221

13.15.9.      Gross assets. 222

13.15.10.   Number of employees. 222

13.15.11.   Trading activities. 223

13.15.12.   Excluded activities. 224

13.15.13.   Eligible employees. 224

13.15.14.   The working time requirement 224

13.15.15.   Material interest 225

13.15.16.   Requirements relating to options. 227

13.15.17.   Type of shares. 228

13.15.18.   Option period – 10 year limit 228

13.15.19.   Written terms. 228

13.15.20.   Non-assignability. 230

13.15.21.   Company reorganisations. 230

13.15.22.   Reorganisations for Schedule 5 purposes. 230

13.15.23.   Qualifying exchange of shares. 230

13.15.24.   Replacement options. 231

13.15.25.   Time limit 232

13.15.26.   Other requirements. 232

13.15.27.   Notification.. 233

13.15.28.   Enquiries. 233

13.15.29.   Annual returns. 234

13.15.30.   Valuation.. 234

14.         Capital gains tax aspects. 235

14.1. Introduction.. 235

14.2. The market value rule. 235

14.3. The relevant provisions. 235

14.4. Unrestricted shares. 236

14.5. Restricted or convertible securities. 237

14.6. Effect on transferor. 237

14.7. Options    238

14.7.1.        General 238

14.7.2.        Market value. 238

14.7.3.        Mansworth v Jelly. 238

14.7.4.        Section 144ZA etc. 239

14.7.5.        Summary. 239

14.8. Other charges. 240

14.9. Employer’s NIC paid by employee. 240

14.10.                   EMI Options. 241

14.11.                   Entrepreneur’s Relief 241

15.         The corporation tax deduction. 243

15.1. Introduction.. 243

15.2. Basic requirements under Chapter 2. 243

15.2.1.        Conditions relating to shares. 244

15.2.2.        Conditions relating to the employee. 244

15.2.3.        Calculation of relief 245

15.2.4.        Timing etc of relief 245

15.3. Relief for options. 245

15.3.1.        Calculation of relief etc. 246

15.3.2.        Takeovers and transfers of businesses. 247

15.4. Additional relief for restricted shares. 247

15.4.1.        Relief available. 248

15.5. Additional relief for convertible securities. 248

16.         Employment related securities and PAYE/NICs. 249

16.1. Introduction.. 249

16.2. PAYE     249

16.3. Employers’ NIC paid by employee. 250

16.4. Chargeable events subject to PAYE/NICs. 251

Appendix: Flow chart for the operation of PAYE. 253

Index    255