Case Study: Benedict Manning v HMRC  UKFTT 252 (TC)
Employers With Share Option Schemes Take Note…
An April 2013 decision of the First Tier (Tax) Tribunal has provided a reminder of the importance for employers of notifying their employees of the requirement to promptly reimburse the employer for income tax payments made on his or her behalf following the exercise of an option under a share option scheme.
The technical background and potential relevance to your share plan
Income tax was due on a chargeable event in relation to a share option. An example of such an event is when an employee exercises his or her share options, i.e. the date on which he or she (usually) acquires the beneficial ownership of the shares. Whether such a charge arises depends on the circumstances and facts and where possible it is advisable to structure an award so that no such charge arises. Typical scenarios when a charge might arise include (and are not limited to):
- Exercise of an Unapproved Share Option Plan (USOP);
- Exercise of an option under a CSOP or EMI in circumstances when income tax is due (e.g. where a CSOP option exercised within 3 years from the date of grant or when an EMI option is exercised with a discounted exercise price; and
- Shares ceasing to be subject to a SIP in circumstances when income tax is payable (e.g. a withdrawal of shares within 3 years.)
Whether any such charge is collected under self-assessment or under PAYE operation again depends on the circumstances and facts but if the underlying shares are considered to be Readily Convertible Assets then the employer is obliged to account to HMRC, via the usual PAYE route, for the income tax and national insurance contributions (NICs) due at that date. The employee must reimburse the employer in full within 90 days for the income tax accounted to HMRC, otherwise he or she becomes liable for a penal tax charge payable to HMRC. Essentially, the payments "withheld" by the employer become treated as an income payment in themselves, and the employee has to pay the "tax on the tax".
In Benedict Manning v HMRC, Mr Manning notified his employer on 28 October 2007, of the exercise of his option to buy shares with a market value of over £100,000 at an exercise price of just over £7,000. His employer paid the tax and NICs on his behalf. Under the share option scheme, Mr Manning was required to repay his employer upon receipt of a statement setting out how much he owed. His employer failed to send him this statement for several months.
The employer only emailed the taxpayer on 28 March 2008 advising him that he had not yet paid the tax in relation to the 2007 option exercise and Mr Manning had to reply to his employer saying he had never been advised of the amount payable. When Mr Manning finally received the statement, he repaid his employer in full, on 11 April 2008, but, due to the employer notification delay, this repayment occurred more than 90 days after the initial payment was made to HMRC.
During a PAYE audit in 2011, HMRC became aware that Mr Manning had repaid his employer outside the statutory time limit. They brought proceedings to enforce the penal tax provisions against Mr Manning. By this point his shares had dropped in value to less than he had paid for them, leaving him significantly out of pocket.
HMRC raised a charge under Section 222 ITEPA 2003 ('S. 222') assessing Mr Manning to income tax of approximately £16,000, which was appealed by the taxpayer.
S. 222 can apply where a payment is made in a 'notional' form where it is not possible to deduct PAYE (such as a share acquisition). Irrespective of whether the employer has duly accounted to HMRC for the PAYE due (as they had done here), if the employee has not 'made good' this amount of tax to his employer within 90 days of the relevant date, the employee will, under S. 222, be liable for a further income tax charge on the amount of tax owed. This is a punitive tax on tax charge.
Mr Manning exercised his share option on 28 October 2007. The share plan stipulated that the employer was responsible for determining the amount of PAYE due. The option agreement also provided that, as a condition of the exercise of the option, the employee was required to pay the amount of any PAYE liability to the company within 30 days of exercise or by the date the company had to account for the tax, whichever was earlier. As this had not happened, the Tribunal concluded that Mr Manning did not acquire the shares until he in fact made payment to the company, meaning he was not 90 days late in reimbursing the company and the "gross up" charge did not apply.
The Tribunal's interpretation of the plan was that Mr Manning's rights had lapsed when he failed (due to his employer's mistake) to pay the PAYE, due within 30 days, following 28 October 2007. The Tribunal concluded, somewhat bizarrely, that this was not therefore the actual date of exercise of the relevant date for S. 222 purposes. The relevant chargeable event under S. 477 ITEPA 2003, occurs only when a person acquires beneficial ownership of the shares. Accordingly, if beneficial ownership occurs only when an obligation to make good is satisfied, there is no relevant chargeable event unless and until the condition is satisfied. The date of exercise, and the relevant date for S. 222 purposes, was therefore deemed instead to be 28 March 2008 and as the taxpayer made good the tax within 90 days of 28 March 2008 S. 222 did not apply.
The Tribunal justified its decision noting the statements of Lord Neuberger in Chilcott and others v Revenue and Customs Commissioners  EWCA Civ 1538 and  that the court should at least consider, and if appropriate adopt, a construction of S. 222 in favour of the taxpayer if such a construction was available.
What Does This Mean For Employers?
The decision seems to vindicate the carefully drafted option agreement, but whilst such provisions can be helpful, no employer will want to find itself having to rely on them. The Tribunal was clearly sympathetic with Mr Manning's plight and, as a result, reached a decision that, in our view, is susceptible to being reversed on appeal on the technicalities, albeit the current result seems to be a fair outcome for the taxpayer.
It is interesting to note that the Tribunal (being deliberately liberal in interpretation and sympathetic to the unrepresented taxpayer's plight) didn't deem Mr Manning to have beneficial ownership of the shares until he had reimbursed the company (on 11th April 2008). As HMRC generally views the date of exercise as the date on which beneficial ownership is acquired (but accepts that beneficial interest in shares normally only passes when an unconditional sale document in signed), it must be considered likely that this determination could be appealed by HMRC.
As such, employers should ensure they have a watertight understanding of the procedural requirements of their own share option schemes, which will usually have been drafted in accordance with relevant legislation. At a minimum they should notify their employees of the requirement to reimburse within the 90 day window. The case demonstrates that the onus is on the employer to communicate the PAYE liabilities on a timely basis as well as recouping them from the employee. It is therefore not adequate to simply notify the taxable values it is equally important to ensure funds are recouped without delay.
Although the liability does not fall on employers, a hefty tax bill, which could have been avoided by a simple notification to the employee of his or her liability and the potential consequences of failing to make it good, is likely to have a damaging effect on morale and could potentially be a breach of the implied term of trust and confidence between employer and employee.
This is particularly so where an employer's share option scheme is operated by a parent company based in another jurisdiction, where the technicalities of UK tax legislation may not be fully appreciated.
The case questions HMRC's conduct and the approach taken in investigating S. 222 ITEPA 2003 compliance. We would advise employers that if they have (as would be considered best practice) the right, under the terms of the share plan, to withhold shares to cover such a liability then this course of action should be considered as an alternative to the pursuit of cash collection but that such withholding also needs to comply with the 90 day time limit.
The good news for employees and employers alike is that the UK Government consultation announced, as part of the Office of Tax Simplification review of share schemes, that it intends to consider repealing the 90 day time limit for reimbursement and replacing it with the date of 6 July following the end of the relevant tax year. This should ease the administrative and cash flow disadvantages of the current system.
Meanwhile this case evidences the importance of on-going compliance and effective and efficient share plan administration. This is a high risk area where employers can easily get caught out in particular where there are conditions of exercise and/or there is a delay between the option exercise and the formalities of transfer being completed and the employee is able to deal with the shares, particularly if the share value has changed in that time. It is also a compliance function that can be outsourced to professionals.
RM2 administers share plans for employers, from small private independent enterprises to large listed companies. To find out more about our plan administration services call Caroline Parker on 0208 949 5522 or email Caroline.Parker@rm2.co.uk. You can also download our Share Plan Administration fact sheet here.