Helpful amendments have been published by the Government. These
address many of the concerns raised where employee trusts used for
employee share schemes come into contact with the new rules on
"disguised remuneration". They are due to be debated in
Parliament today.
Although there are still some areas of difficulty, these amendments
(together with some expected HM Revenue & Customs
("HMRC") guidance in the form of answers to FAQs) should
mean that most quoted companies should not have to change their
pre-existing practice of making, hedging and satisfying employee
share plan awards through employee trusts. The publication of final
amendments comes after several months of lobbying on the relevant
issues.
HM Revenue & Customs has not yet updated its FAQs, but is
expected to do so in due course.
While the Finance Bill is not anticipated to become law until
mid-July 2011, the disguised remuneration legislation is backdated
to 6 April 2011 or in some cases 9 December 2010.
Disguised remuneration and "earmarking"
Under the disguised remuneration rules, an upfront income tax
and National Insurance contributions ("NICs") charge may
arise if a third party (principally an employee benefit trust)
"earmarks" cash or other assets (including shares) for an
employee with a view to taking a later step (e.g. transferring the
shares to the employee). It may also arise in other cases.
While this legislation was not aimed at employee share plans (it
was principally targeted at remuneration schemes such as family
benefit trusts, loans and certain pension arrangements) they are
caught by the disguised remuneration legislation as it captures an
employee trust granting, or agreeing to satisfy, share options or
other share-based awards to named employees, or taking action in
relation to those awards (e.g. buying shares for that purpose).
Employee share plan exemptions
Even when the original legislation was published in December
last year, there were a large number of exemptions. These were
expanded further in the draft legislation provided after the April
budget, but still not sufficiently and companies and trustees were
understandably nervous about operating arrangements without a
satisfactory position being reached. However, the amendments
published last week now finally appear to provide a workable
exemption regime for employee share plans.
Broadly, earmarking in advance of a proposed award or in connection
with an existing award should not now be a problem, provided
that:
- the maximum period over which a share award or share option can vest or be exercised is ten years. This should not be a problem for most quoted companies as it reflects existing practice (the previous draft legislation had a limit of five years, which would have caused concerns);
- the terms of the award or option provide that it will lapse if specified conditions (e.g. performance conditions or continuing employment) are not met on or before the vesting date and there is a reasonable chance when the award is granted that the award will lapse. The award may also provide for partial lapse. Further guidance is awaited on what HMRC considers to be a "reasonable chance". The exemption will still be available where employees are able to receive their shares early if they leave or the company is sold and in other events, although further guidance is awaited on this;
- the employee will be subject to income tax and NICs on or before the vesting or exercise (or would be but for a relief);
- there is no tax avoidance motive; and
- the number of shares earmarked must not be more than the maximum number reasonably required.
A helpful change made in the most recent draft is that awards
may be made by any person – the April draft required
awards to be made by the actual employer (rather than the parent
company or an employee trust) which appeared very
restrictive.
An employee trust may also make cash awards, although on much more
restrictive terms.
There are still a number of areas where we understand that HMRC
will fill in missing gaps through providing answers to FAQs. These
include references in the legislation to determining whether there
are sufficient shares being required to be done on a scheme by
scheme (or even award by award) basis, whereas in practice employee
trusts are funded looking at all commitments as a whole. However,
we hope that HMRC will only in practice apply this legislation
where there is tax avoidance and take a reasonably broad view and
accept a company's own view of its hedging requirements.
Similarly, the legislation can still currently be read as requiring
shares which have been allocated to meet an employee's award
having to be sold to the extent not used to satisfy that award,
but, again, we hope that HMRC will not enforce such an impractical
reading.
Companies which only issue shares to satisfy awards
If shares will always be issued to meet awards (rather than provided from an employee trust) then the disguised remuneration legislation is not a concern as there is no relevant third party.
Cashless exercise arrangements
Most employees now exercise options on a cashless exercise basis
and direct that the exercise price, income tax and NICs arising on
exercise is funded by selling the shares they receive rather than
providing a cheque upfront.
The problem here is that the transfer of an asset (including
shares) can be a chargeable event under the disguised remuneration
legislation. If an employee pays in full, then this provides a
complete exemption, but frequently the employee pays shortly after
the transfer rather than before. This was a problem with the
previous drafts of the legislation, but seems now to have fallen
away as an issue because payment can now be made at or around the
time of transfer which gives sufficient time for shares to be sold
and provide the necessary cash.
Where an express loan is provided (which is rare) the legislation
has been amended so that a charge will not now arise if the
employee reimburses the employee trust within forty days of the
date of exercise of the option or making of the loan.
In other cases where an employee acquires shares from an employee
trust at below market value, however, there would be an upfront
income tax and NIC charge on what has not been paid over. Where
possible, therefore, partly-paid share schemes should be structured
through a company issuing shares.
Action
The amendments to the draft legislation are good news for
employee share plans, although further guidance is still awaited in
some areas.
However, in almost all cases, the net result after some months of
uncertainty is that it is business as usual.
For a copy of the proposed amendments please
click here.
For more background on the disguised remuneration legislation,
please see our Law-Nows:
- New anti-avoidance provisions covering disguised remuneration
- Disguised remuneration – good news for employee share plans
- Disguised remuneration – an update for employee share plans
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 17/05/2011.