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”)  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 court heard the two appeals simultaneously (Cyclops Electronics Limited, Graceland Fixing Limited v HMRC  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.
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.