UK: Form 42: How Much Should Employers Know About Their Employees?

The in-house employee taxes manager is required to deal with a wide range of issues concerning employees – issues which, in a large accountancy and consulting firm, would span four or five departments. The role within an in-house function requires broad knowledge, which can be supplemented with in-depth expertise from advisers whenever required.

Part of the challenge of the job lies in dealing with a large number of departments in which, surprisingly, work colleagues do not live, dream, work, eat and sleep taxation! That is why the in-house tax manager needs to act as an early warning system; to try and ensure that, in major transactions, tax of all kinds is at least considered before irrevocable decisions are made. Creating a shadow tax team of individuals across the business, one which knows enough about tax to refer appropriate questions to the tax manager, is crucial. In any large organisation, it is neither possible, practical nor desirable for a single individual to scrutinise all transactions.

In the course of day-to-day work, the tax manager needs to establish contacts in departments as diverse as facilities, payroll, share schemes, building services, cost centres, domestic HR, international assignments HR, benefits, finance and IT, as well as with colleagues in corporate tax and VAT. Into this varied diet, new ingredients are regularly thrown to keep everyone on their toes. Form 42 has recently provided just such extra spice.

Form 42 has not yet reached the iconic status of the forms P45, P60, P11D or IR35. It surely will become as famous (or infamous!), unless share schemes fall out of favour as a way of remunerating employees. Form 42 may yet rise to assert its place in the pantheon of Inland Revenue forms, acronyms and names that are known to a wider audience than UK tax professionals.

The form, which reports unapproved share options, share awards, financial instruments, etc, was conceived in April 2003, when the Finance Bill for 2003 was introduced. This 16-page form had a gestation period– longer than that of a human being but somewhat shorter than that of an elephant– before it was born in March 2004. I suspect that few reasonable people would argue that there was no need for the form. It provides a formal layout for information about unapproved forms of share-based remuneration. Although employers were required to report similar information for share options before the introduction of Form 42, there was no prescribed format to facilitate and remind employers of the requirement to file. With share/securitybased remuneration schemes gaining popularity over the past 10 years, some might say that the need for a formally constituted return was overdue.

Encouraging employers to provide reasonable information regarding income and employee share schemes should be in the interest of all taxpayers. However, the devil, as ever, is in the detail. Companies face the major challenge of collecting, monitoring and recording a very large quantity and variety of information.

There is certainly a justification for share scheme reporting, as it allows the Inland Revenue to cross check the information on individuals’ tax returns. Many employers will have found that it has generated a greater need for robust information systems and processes. Ensuring that the increased amount of information required for Form 42 is available in the three months after the end of each tax year has now become essential for employers.

If you add into the melting pot the additional penalties for late submission, completing Form 42 in its first year proved an enormous challenge. At HHG, we needed input from HR, finance, share schemes specialists, our investments department and payroll, as well as trustees within a short period of time in order to produce the requisite information on time by 6 July. This reinforces my belief that one of the core functions of any in-house tax team is to ensure that disparate departments are not only aware of tax issues as and when they happen, but are also prepared to play their part in achieving the common goal.

One of the more interesting points about share scheme reporting is the extent to which it requires the employer to know considerably more about employees than might intuitively be expected. The company needs to check a residency box if the individual is either not resident or not ordinarily resident in the UK for tax purposes. This has logic to it, as the treatment of share award options does depend on residency status at grant and, potentially, at exercise as well.

As many employers will know, this gives a host of problems. Since the advent of Self-Assessment, the Inland Revenue has not, as a rule, issued residence rulings. It can prove difficult, therefore, to establish what an employee’s residence status is and, consequently, how to treat share scheme events for PAYE, NIC and Form 42 reporting purposes. Accordingly, in order to determine an individual’s residence status, the employer must either take the employee’s word on the matter or enquire further. This could lead to the employee having to provide information that he or she would prefer to keep private.

Residence, like a number of other areas connected with taxation, depends on that nebulous concept, intention. Briefly, if an individual intends to stay in the UK for more than three years, he is resident and ordinarily resident from the outset. If an individual does not intend to stay more than three years and does not show any signs of intending to stay, such as buying property or entering into a long lease in the UK, then it is possible that he may not be ordinarily resident in the UK. Clearly this affects not only the tax treatment of shares but also a number of other valuable tax reliefs which are available.

Yet ultimately, the availability of the relief is not based solely on the employer’s actions but also on the employee’s intentions. This can lead to some interesting conundrums. Say a company has every intention of returning an employee to his home country after two years, but the employee has every intention of making the UK his home for a considerably longer period, if necessary by changing employer.

The employer may well consider the employee resident but not ordinarily resident, but the employee’s intention to stay beyond the three-year limit would make him resident and ordinarily resident. Conversely, the employer may wish the employee to come to the UK for a considerable period of time but the employee may have no intention of staying that long. These factors can have a very significant (and complex) effect on the treatment of employees’ participation in the share scheme.

Clearly there are issues of confidentiality at stake. Moreover, the intention may not be a work-related one, but could relate to either the making or breaking of personal relationships. This can be a delicate subject to deal with, particularly where the tax manager is requesting what can be perceived as personal information from senior employees and directors.

In its thirst for information, the Inland Revenue requires companies to find out large amounts of personal information about their employees and to retain this information for a very long time, currently six years.

By virtue of the tax laws, companies are required to hold a substantial amount of information on employees, including their marital status, employment history, whether they are on income support (for example, tax credits) and whether they have disabilities. Indeed, the position is more burdensome in multinational companies, where the requirements to hold personal data for individuals may differ from one country to another.

The conclusion must be that there is a limit to the information that it is comfortable for a company to hold and collect from its employees. The only alternative to the requirement for companies to hold so much information seems to be for the tax and benefits system to be less governed by individuals’ personal circumstances. Even the most organised and stable of individual’s intentions can be clouded in secrecy and ambiguity.

Whilst it may appear inequitable for an employee’s personal circumstances to have such a bearing on an employer’s compliance requirements, there is no indication that this will change in the near future. Tax managers face the ongoing task of ensuring systems and procedures are in place to capture relevant information for statutory returns whilst recognising the sensitivity of the information being held.

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