Keeping employee share plans simple - and safe
Two separate companies have recently lost appeals against a
PAYE charge on the acquisition of employment related securities by way of loan
notes. In this case, several thousand
pounds’ worth of tax and NICs became payable by individual directors in
connection with arrangements put in place over a decade earlier.
The case demonstrates clearly that, even with excellent tax
advice, if arrangements are put in place that have a tax avoidance motive, and
little or nothing in the way of commercial or business purpose, there is a high
risk that a tax charge will apply.
In particular, the judge at the tribunal noted the clear
difference between this type of arrangement and the general concept of employee
share schemes (Lord Reed in Deutsche Bank Group Services (UK) Ltd v HMRC (“Deutsche Bank”) [2016] STC 934): “[I]t is
difficult to accept that Parliament can have intended to encourage by exemption
from taxation the award of shares to employees, where the award of the shares
has no purpose whatsoever other than the obtaining of the exemption itself ….
The encouragement of such schemes, unlike the encouragement of employee share
ownership generally, or share incentive schemes in particular, would have no
rational purpose”.
Great care should be taken whenever securities are awarded
to employees or directors of companies to ensure that tax avoidance legislation
does not come back to bite at a later date.
Perhaps the key message to take away from this case is that if it looks
too good to be true, then it probably is.
The case
The court heard the two appeals simultaneously (Cyclops
Electronics Limited, Graceland Fixing Limited v HMRC [2016] UKFTT 487 (TC));
because the facts were very similar. The
Tribunal Judge also noted that several hundred other appeals had been
designated “related cases”. It seems
likely, therefore, that a number of private companies, particularly those that
are director-owned and managed, may find the outcome of interest.
In each case, a director or directors of the companies in
questions received loan notes. The loan
notes were, it was argued, restricted securities for the purposes of Part 7 of
Income Tax (Earnings and Pensions) Act 2003 (ITEPA). In particular, because the loan notes
contained forfeiture provisions, no income tax or NICS was payable on the
receipt of the loan notes (section 425 ITEPA).
(In addition, and separately, there was no income tax or NICs on the
redemption of the loan notes.)
However, HMRC argued successfully that the forfeiture
provisions carried no real commercial or business purpose – they were
“commercially irrelevant and designed only to secure the benefit of the tax
exemption” (even though the loan notes did have some commercial effect). The main purpose, in both cases, was to
secure the income tax and NICs savings.
The loan notes did not fall into the relevant part of the
tax legislation. The loan notes were
therefore subject to income tax and NICs in the same way as a cash payment
would have been.
Conclusion
RM2 focuses on commercially driven share plan arrangements for employees and directors that are recognised by government and the tax authorities. If you’d like advice on setting up a share scheme, please contact us.