Taxation of share awards
Our Head of Tax, Chris Riley highlights some frequent factors that can provoke some issues.
Most listed companies will provide some form of share-based remuneration to directors and key management. I don’t need to emphasise that they’re a tried and trusted way to recruit and incentivise people to join and stay with a company and encourage behaviours to drive shareholder value. What’s more, in the case of option arrangements they provide a useful reduction in the cash cost of remuneration.
However, there are always tax considerations in respect of the award of shares, or future rights to shares, for employees which is likely to give rise to employment tax exposures whenever shares are issued at cost that is lower than the value of shares on the date that they are issued (which includes particularly the exercise of options or warrants). How these have been dealt with is an issue that arises frequently in tax due diligence in both private and public transactions. At best, potential tax issues can add cost and possible delays. At worst, we’ve seen employment -related share issues cause a deal to collapse.
Everyone’s an employeeIf a person is, or has been an employee of a company in which they receive shares, it’s difficult to argue that any shares that they acquire are obtained otherwise than through their employment – unless they are obtained on the open market. Where an individual leaves employment holding unexercised share options, they’ll remain employment-related share options for a further seven years after they leave.
Directors are always considered employees for the purposes of these rules, whether they’re on the payroll or otherwise – this is a key risk that’s often overlooked. This also extends to non- executive directors who provide their services in a personal capacity, with the HMRC strictly treating any remuneration or fees they receive as liable to PAYE/NIC.
The tax risk belongs to the companyIn a private company context, the impact of any employment income arising from share transactions for employees will often be a personal matter for the individual recipient. However in a listed company setting, as the shares can be sold, notwithstanding the impact of any blackout periods or lock-in provisions, the legislation considers that as the shares are convertible for cash (readily convertible assets – RCAs) and as such employment income events, they count as PAYE/NIC for the company.
Although many share option arrangements will include an indemnity clause to enable the company to recover from the employee any PAYE charges that are initially payable by the company, this could prove to be a troublesome burden for one exercising share options (and crystallising a liability) if there’s no immediate prospect of liquidity.
The s431 electionMany shares issued by companies are subject to some form of restriction that may affect their value. For example, in a privately- owned company, a shareholder may not be free to dispose of their shares to anyone they choose. On selling their shares, or if the rights attached to the shares are amended to remove that restriction (for example on listing) then the effect of value on that restriction drops away, and the shares theoretically increase in value.
Where issued shares are subject to a form of restriction that affects their value, the default presumption is that they’re received by the employee at that restricted value. This reduces the tax impact at the time of acquisition if the full price isn’t paid. However, when the restriction is later released (either on the sale, or other change of rights to release the restriction) the increase in value is taxable as PAYE/NIC. Assuming shares have grown in value, the value gain at this later date is likely to be far higher than the value of the restriction at the outset.
This future charge can be prevented by making a joint election between the employer and employee at the time that the shares are issued that the effect of restrictions on value is disregarded on the acquisition of the shares. In most cases, this is strongly advisable to mitigate potential future charges at a low up-front cost (especially if shares are being paid for at the outset anyway). However, the election must be made within 14 days which can often be missed, giving rise to complications at a later transaction when the proof of an election can’t be provided.
Reporting mattersCompanies that enter into share arrangements with UK-based employees will have annual reporting requirements in respect of any matters concerning the acquisition of shares or options and, in some cases, disposals of shares.
Accurate and timely reporting to HMRC is important for any employee share arrangement, but absolutely critical in respect of tax advantaged schemes to ensure that the tax advantaged status is secured and retained. In particular, Company Share Option Plans (CSOP) schemes must be registered with HMRC, and were Enterprise Management Incentive (EMI) options are issued, they must be notified to HMRC within 92 days of a grant. Failure to meet these conditions would lead to the options being considered unapproved, giving rise to significant tax risks on their exercise.
Cross-border mattersFinally, the thoughts here concern the tax exposures in the UK for employees and directors receiving shares. For international businesses it’s likely that share schemes will also be considered for key management in local operating subsidiaries. In addition, primarily UK-based management personnel may spend sufficient time overseas to have payroll obligations in their local operating jurisdictions.
Most countries will have similar provisions to the UK to capture employment tax costs arising on shares issued to employees working in their jurisdictions, even when the shares themselves are in the UK parent company. However, tax authorities don’t operate to rules that are exactly the same, therefore there may be significant differences in the timing, calculation, and even the valuation basis for shares received by employees for tax liability purposes. Local advice should always be sought to prevent risk and liabilities accruing.