Employers with share plan participants in the UK can often receive UK corporate tax relief for the gains that are made by their employees when they acquire the shares. Unlike many jurisdictions, corporation tax relief is available on a statutory basis with no requirement to enter into a corporate recharge agreement. However, a key point to bear in mind is that employees must acquire ownership of shares (even if they are immediately then sold).
Companies that help their employees by choosing to ‘net settle’ the share awards to resolve the PAYE and NIC liabilities can find that they lose out on corporate tax relief. HMRC is increasing its enforcement activity around share issues and, because it is aware that net settlement can lead to compliance failings, will examine the paper trail around share options during employer compliance checks.
Net settlement or ‘settling’ is where a company decides to make an employee share award through a combination of issuing fewer shares and in part using cash. The cash element is equal to the PAYE and employee NIC due and is paid to HMRC. The value of the shares received by each employee is equal to the post-tax (net) value that the employee would have enjoyed had they received all the shares and sold some to cover the PAYE and NIC due.
Effectively, fewer shares are issued and the company has therefore reduced the share dilution suffered by its shareholders. The company has instead used its own cash to fund the PAYE and NIC. The problem, however, is that the UK statutory corporate tax deductions depend on the employee acquiring the shares. The fewer shares that are actually received, the smaller the UK CT relief.
This means that many companies have been over claiming CT relief in respect of employee share plans. HMRC is aware of the issue and seeking to identify companies in this situation.
A net settlement approach reduces the number of shares issued (and therefore reduces the statutory CT relief available). This contrasts a “sell to cover” arrangement is different where the employee receives the full number of shares but then sells some to cover the taxes due.
Let’s consider a share award over 100,000 shares at a share price of £1 at acquisition. No price is payable by the employee for the shares and this triggers liabilities to income tax at 45% and NIC at 2%.
|Sell to cover
The company issues 100,000 shares.
The employee receives 100,000 shares worth £100,000 triggering a tax and NIC bill of £47,000.
The company issues 53,000 shares.
The employee receives 53,000 shares worth £53,000.
|The employee sells at least 47,000 shares to cover the tax bill.
The company pays £47,000 out of its own cash to HMRC to cover the PAYE and NIC due on the shares and cash.
|The company claims corporate tax relief on £100,000.
The company claim corporate tax relief on £53,000.
Assuming there is little movement in the value of the shares, the employee is in roughly the same position. However, using the net settlement approach, the company has missed out on a deduction for £47,000.
Non statutory deduction
Where an award is net settled, it is necessary to consider whether a corporation tax deduction is available for the company cash paid to HMRC (eg the £47,000 in this above example) through other routes?
There is certainly no statutory corporation tax deduction available for such payments as they are made instead of issuing shares. Therefore, the availability of a deduction will differ depending on the precise circumstances for each company – however, it is worth looking to see if there is an alternative route to claiming corporation tax relief for such staff-related costs.
In such circumstances, it is necessary to look for an accounting charge through the profit and loss account, and then to see if a deduction can be claimed under general principles. It is often the case that the accounting charge will be less than the full amount of PAYE and NIC paid by the company on the employees’ behalf and this generally means that any deduction available (if any) would be less than the cash actually paid. (On a side note, HMRC recently lost an Upper Tribunal share plan case where it was found that if there was an expense it does not need to be the case that monies had to flow for a deduction to be available.)
Actions to ensure your group claims the right tax deductions
It can easily be the case that an employing company may think that the group net settles but ‘sell to cover’ is actually used and the parent company issues the full number of shares. So the first action should always be to ensure that you fully understand the process for settlement of your employees’ liabilities on share options by asking:
- Is net settlement used?
- Is sell to cover used?
- Is there a combination?
It is also important to check:
- What corporation tax deductions have been claimed historically?
- How many years has our current process been in place?
- Have we reported all share option activity correctly on Employment Related Securities returns?
- If net settlement has been used, have we examined the accounting charges and identified any alternative deduction basis that can be used?
When you have the answers to these questions you can decide on actions and process going forward. It may be decided that net settlement should not be used for the UK employees of a global group and this may require processes to change for companies.
How we can help
For help and advice on all aspects of using share plans and options please get in touch with your usual BDO contact or David Gardner.
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