Making Share Schemes more Simples
The independent Office of Tax Simplification (OTS) was established a year ago this month to provide advice to the Chancellor on options to improve and simplify the UK's tax system. David Jack, the Chairman of the OTS, has now written to Treasury Minister David Gauke to tell him that, among other things, he intends to look at employee share schemes. Mr Jack says that employee share schemes have too many complexities and traps for the unwary. We cannot but agree.
Advice for free
Apparently the OTS will be inviting applications for "secondees" to assist it with its work. These will be unpaid. We wonder whether this is a further manifestation of the Big Society where the Big Idea seems to be to get as many people to do as much work as possible free of charge. Yet we suspect there will no shortage of volunteers.
What might the review mean for employee share schemes? The work of the OTS has not so far been particularly radical. In March this year we reported on the first two reports issued by the OTS, weighing in at 186 and 75 pages respectively. The reports contained some useful ideas about the Venture Capital Trusts, the Enterprise Investment Scheme and Entrepreneurs' Relief. But in relation to employment related benefits, the OTS confined itself to marginal issues such as the abolition of relief for meals on cycle-to-work days, luncheon vouchers and miners' coal allowances. Perhaps Michael Jack was conserving his strength.
What's been going on?
The main reason for the complexity of the tax legislation around employee share schemes is that tax efficient share schemes deliver gains in a form subject to Capital Gains Tax (CGT), not income tax. Since the rates of CGT are much lower than top rates of income tax, huge ingenuity has been applied by tax advisers to designing "employee share schemes" which have the effect of turning what would have been income (water) into Capital Gains (wine).
As long as income is taxed more highly than capital gain, this problem will remain. This is despite great efforts by the Treasury to stem the leakage. One of the more effective methods has been the DOTAS system - the Disclosure of Tax Avoidance Schemes. This places tax practitioners in the rather odd position of being legally obliged to ask themselves whether the advice they are giving to clients could amount to tax avoidance, and, if it could, requiring them to report themselves to the authorities. HMRC claims that many billions of pounds of tax has been saved by this system, and they may be right. But every time a scheme is stopped, new regulations are created and/or new legislation is added to the statute book.
The most infamous recent example is the new Part 7A to ITEPA 2003, introduced in the 2011 Budget. This was brought in mainly to counter the provisions of loans by employee benefit trusts and other vehicles to directors and employees. Often these loans were made without a real expectation of repayment, and therefore provided spendable cash to the recipient which was virtually tax-free.
The problem was that those who were asked to draft this legislation tried to anticipate every possible way in which the tax avoidance industry might counter it. The result has been more than 60 pages of the most obscure and, in places, unfair legislation. This material is so opaque that, in fact, it is doubtful if anyone in the country fully understands it, least of all those who drafted it, and has been roundly condemned from every side. If Michael Jack and his team achieve anything, they should remove this monstrosity from the statute book.
Notwithstanding these issues, we believe there are some real opportunities to simplify the employee share schemes regime. Why, for example, do we need two government sponsored share options schemes: the Enterprise Management Incentive (EMI) and the Company Share Option Plan (CSOP)? And surely we could do away with the arcane rules, such as the one about companies who operate joint ventures being at risk of being unable to offer EMI options. Why do we need separate SAYE schemes if we can run one of other government sponsored option schemes alongside a conventional savings contract?
One of the most radical suggestions in this field was made in the 2006 Forsyth Report commissioned by George Osborne when he was in opposition. In essence this suggested replacing all employee share schemes with a single regime whereby employees can be given shares upfront without a tax charge. On sale of the shares they pay income tax on the original value and capital gains tax on any gains. The report also suggested a rate of capital gains tax which tapers to zero over 10 years. This is an attractive idea in concept but we can already see the tax avoidance specialist sharpening their pencils. What about taking out loans against the (initially tax-free) value of the shares acquired?
Facing the reality
As we observed earlier, the real difficulty is that tax avoidance will always exist where rates of tax on income differ from those on capital gains. And this will continue to apply across the tax system, not just in share schemes. But there are further issues. When establishing employee share scheme, especially for unquoted companies, most of the complexity is not in the rules surrounding the schemes themselves. The real complexity lies in the interaction of the commercial objectives of the schemes with the intricate provisions of company law and accounting standards, assorted European directives, company valuation issues, employment law and the law and practice relating to trusts which, despite the infamous new Part 7A mentioned above, continue to have a valuable role in the design and operation of employee share schemes.
The reality is that, in the world of employee share schemes, complexity will be with us for the foreseeable future.
If you would like to discuss any of the issues raised in this article in more detail, please call 020 8949 5522 and ask to speak to one of our advisers.