The 50% tax rate: dealing with share scheme anomalies
The introduction in April 2010 of the new 50% rate of income tax has created an anomaly for some share schemes where the gains are subject to PAYE. Situations where the problem could arise include the exercise of unapproved options or discounted EMI options, or the vesting of Long Term Incentive Plans. The gains will be subject to PAYE if (broadly) the shares are quoted or form part of the share capital of a subsidiary of a private company; in other cases the income tax is collected via self-assessment.
The PAYE problem arises because the tax is calculated on a monthly basis. A large taxable share scheme gain in a particular month may therefore trigger a liability at 50% even though the annual tax calculation at the end of the year may show tax due only at 40%. Accordingly there may be an over deduction of tax in the short term.
If the individual can afford to pay the tax, then the situation will be corrected later by means of a tax refund. If not, the individual may need to sell shares to cover the bill. Alternatively, the issuing company may invoke rights under the share scheme agreement to sell shares to cover the liability. In either case, the individual will have lost shares and potentially, therefore, the opportunity for further capital gain.
A further consideration arises in cases where the participant share options or other share rights have been acquired from an Employee Benefit Trust (EBT). If the trust sells shares to meet the tax bill, could the participant have a claim against the trustees? After all, the trustees have a fiduciary duty to act in the best interest of the beneficiaries.
In our view the best approach is to anticipate the problem well in advance, and ensure that employees who may be affected understand their position. If the employee cannot finance the shortfall, the company could consider making a loan, though if the loan is interest free there will be a tax charge based on HMRC's official tax rate, currently 4%. Care should also be taken that any loan to a shareholder in a tax year is reversed within 9 months of the year end, otherwise an unexpected charge to advance corporation tax may arise.
As with many potential tax problems, the secret is to be forewarned and forearmed.
If you would like more details of the issues raised in this article, please call us on 020 8949 5522 and ask to speak to one of our advisors.