Capital Gains Tax - the review by the Office of Tax Simplification
The Office for Tax Simplification’s (OTS) most recent report doesn’t just look at tax simplification, but includes policy recommendations relating to capital gains tax (CGT) - an interesting extension of the Treasury’s usual instructions to the OTS. Some of the recommendations, if implemented, could create significant negative outcomes for a variety of government recognised tax advantaged schemes, including Enterprise Management Incentives (EMI), Sharesave/SAYE and Share Incentive Plans (SIP), as well as other popular plans such as Growth Share Plans.
Alignment of tax rates
Probably the most important point in the report relating to share schemes is the suggestion that the government suggests a closer alignment between the rates of CGT and income tax. The argument is that the current high differential between those rates can “create … an incentive for taxpayers to arrange their affairs in ways that effectively re-characterise income as capital gains”.
This is a reasonable argument. Readers of previous OTS reports may remember that this differential has previously been referred to in the OTS review of non-tax advantaged share schemes in 2012, when the OTS recognised the various attempts to deliver value to employees to be taxed as a gain rather than as income. That report also noted the raft of anti-avoidance legislation created to preclude the use of such tax planning.
RM2 does not have any particular concerns about the points made by the OTS here, and we recognise that certain share plan arrangements continue to be driven very strongly by tax planning rather than a desire to motivate and involve employees.
All employee share schemes
Our main concerns lie with the approach to tax advantaged schemes, including
those aimed at all employees such as SAYE and SIP. These long-standing and well understood
vehicles give all employees – not just higher earners - the opportunity to
become shareholders and part-owners of their employing company in a way which
would otherwise simply not exist.
In particular, we note that the report references the argument that share schemes provide “a strong incentive to forgo salary in favour of other more lightly taxed forms of remuneration, for those with the financial flexibility to do so”.
There are two points here:
- firstly, of course, that the all employee share plans are not aimed at higher earners with financial flexibility; indeed the financial limits on those schemes are so low as to be almost irrelevant to anyone described as a “higher earner”. For example, the SIP allows an individual to use a maximum of £1,800 p.a. out of pre-tax salary to buy shares in their company; and
- secondly, in respect of Enterprise Management Incentives in particular - is that it is true that many cash-strapped smaller companies will offer options to attract key hires, in return for a lower salary. That was the whole point of EMI! Inevitably, the EMI option will deliver tax benefits only if there is a capital event and, if that happens, HMRC will have collected plenty of tax in the meantime from what has obviously become a successful company. In other words, EMI is at least self-financing for the Treasury, and probably a big money earner. There seems little doubt that for a high earner this is very much not a “more lightly taxed form of remuneration” – no remuneration is in contemplation, and there is a significant risk to the participant that the option will in fact never deliver the hoped for capital outcome.
Think like owners
In RM2’s experience, in terms of tax advantaged share plans, the tax benefits of such schemes are a motivator towards adopting a share scheme, but not a driver – in much the same way that a tax advantaged ISA or pension plan encourages saving. Business owners wishing to implement a share plan invariably cite employee motivation, employee retention and the general concept of “making employees think like owners” as the reasoning behind share plan establishment. Cross-party support for these plans by governments of all hues demonstrate the same intentions, underpinned by research showing superior performance in companies with broad-based employee share plans.
We recognise the importance of simplifying the tax system, and are not averse to some closer alignment of CGT and income tax rates where there is clear evidence of significant tax avoidance and lack of commercial intent.
Nonetheless, we very much hope that subsequent OTS reports will take a more holistic view of the benefits of employee share schemes, not least benefits to HM Treasury which needs successful companies from which to collect taxes. The current view seems very myopic and may result in the employee share schemes baby being thrown out with the tax avoidance bathwater.
If you would like to speak to us about your employee share scheme email us at firstname.lastname@example.org and one of our advisers will arrange a call with you.