Disguised Remuneration – Position as at September 2011
01 September 2011
Introduction
On 18 August, HM Revenue & Customs (HMRC) issued its near-final guidance on the 'Disguised Remuneration' legislation. This reiterated the most important exemption for conventional employee share plans which HMRC had included in its earlier guidance. That is, there is no "earmarking" (and therefore no tax charge) where the trustee of an employee benefit trust holds a pool of shares but does not know the number of shares awarded to individual employees.
However, even if this approach is adopted, there are circumstances where the trustee could become aware of how many shares have been awarded to an individual and therefore we recommend that you ensure that your awards fall within one of the exemptions from earmarking contained in the actual legislation, as well as taking advantage of the "share pool" exemption where possible.
This briefing outlines the main exemptions for conventional employee incentive plans contained in HMRC's guidance and in the legislation itself.
Actions
- In order to come within the "share pool" exemption you should review your arrangements with your trustee to ensure that the size of individual awards are not communicated to the trustee until shares are due to be delivered to participants.
- You should also check whether your share plans fall within the statutory exemptions, most conventional plans should do so.
Background
The disguised remuneration legislation took effect on 6 April 2011. It creates an income tax charge for an individual who is a UK taxpayer where trusts, or other third parties, earmark an asset, or provide a benefit, which relates to that individual's employment. The legislation contains extensive exemptions for the use of trusts in association with deferred remuneration and conventional share plans. The main purpose of these exemptions is to prevent an individual having an up-front tax charge where a trust is used to hedge specific awards or options.
Exemptions available under the HMRC guidance
Although HMRC can change or remove its guidelines on legislation and therefore relying on the HMRC guidance is not as certain as relying on an exemption in the underlying legislation, HMRC has consistently said that the disguised remuneration legislation was not intended to catch conventional share plans and therefore we believe the guidance is unlikely to change for the worse.
The "share pool" exemption
The share pool exemption applies if a trustee holds a pool of shares but does not know how many shares are being held for specific individuals. As many companies currently provide the trustees of their employee benefit trusts with a list of individual awards soon after the awards have been made, this approach would need to be changed so that the trustees are informed that awards have been made but are not able to work out the number of shares awarded to any particular employee.
However, it may not always be possible to adopt or maintain this position, such as where:
- awards to directors are disclosed to the market and the trustee can link its purchase of shares to those awards;
- the awards are granted by the trustee;
- the trustee has purchased shares for awards since the legislation came into force on 6 April 2011 and it knows how many of those shares relate to specific individual awards;
- the trustee is also the share plan administrator or, possibly, is in the same corporate group as the administrator;
- prior to vesting, details of individual awards are provided to the trustee.
Many of these scenarios are quite common and therefore we believe the share pool exemption is useful but is not watertight and that companies should also look to see if their share awards fall within the statutory exemptions set out in the legislation and which are summarised below.
Share sourcing exemption
The new guidance has also created a new general exemption. If a company does not make a final decision as to the source of the shares it will use to satisfy awards (i.e whether new issue shares, treasury shares or shares held in a trust) until vesting then the fact that some shares are being held in a trust which could potentially be used to satisfy those awards will not mean that those shares are treated as earmarked. This exemption is probably of limited use as most companies make a decision on the source of shares much earlier in the life of an award than vesting.
The statutory exemptions
We describe below the main statutory exemptions for incentive plans and include some clarifications contained in the new guidance.
Hedging of unapproved options
The exemption from a tax charge on the earmarking of money or shares for an unapproved share option applies if the option and the earmarking of shares satisfy various conditions, the main ones of which are as follows:
- under the terms of the option, the option must not become exercisable until a specified date (the vesting date) which can be up to ten years after the grant date – HMRC guidance indicates that early exercise and delivery of shares, such as in the case of "good leavers" and takeovers, is acceptable;
- the vesting of the option must be subject to conditions and there must be a reasonable chance, as at the grant date, that the conditions will not be met and, consequently, the option will lapse (in whole or in part) – HMRC guidance indicates that "good/bad leaver" rules will satisfy this requirement and that discretion to treat a "bad leaver" as a "good leaver" is acceptable. It is important that the condition is not so soft that the vesting of the option is effectively guaranteed;
- the option must be exercised before ten years have elapsed from the date of grant and the exercise must result in an income tax charge for the individual;
- the number of shares earmarked must not exceed the maximum number of shares which might reasonably be expected to be needed for satisfying the option. HMRC guidance says that this can usually be up to 100% of the shares under option; and
- there is no connection between the earmarking and a tax avoidance arrangement.
This exemption also applies to the hedging of phantom options where cash is paid on exercise, based on the value of the shares at that time, and to earmarking within three months before the grant of an option.
There can be a tax charge if shares remain earmarked for an option following its lapse or revocation. This can be avoided if the shares fall back into an unallocated pool following the lapse or revocation. This is a good reason for adopting the share pool approach described above.
Hedging of unapproved share awards
An exemption from a tax charge on the earmarking of money or shares for an unapproved share award applies if the awards and the earmarking of shares satisfy various conditions, the main ones of which are as follows:
- under the terms of the award, the shares are to be received by an individual on a specified date (the vesting date) which is not more than ten years after the award date – HMRC guidance indicates that early delivery of shares, such as in the case of "good leavers" and takeovers, is acceptable;
- the vesting of the award must be subject to conditions and there must be a reasonable chance, as at the award date, that the conditions will not be met and, consequently, the award will lapse (in whole or in part) – HMRC guidance indicates that "good/bad leaver" rules will satisfy this requirement and that discretion to treat a "bad leaver" as a "good leaver" is acceptable. It is important that the condition is not so soft that the vesting of the award is effectively guaranteed;
- vesting on or before the end of the vesting date must result in an income tax charge for the individual;
- the number of shares earmarked must not exceed the maximum number of shares which might reasonably be expected to be needed for satisfying the award – HMRC guidance says that hedging up to 100% of the shares under award is usually acceptable; and
- there is no connection between the earmarking and a tax avoidance arrangement.
This exemption also applies to the hedging of phantom awards where cash is paid on vesting, based on the value of the shares at that time, and to earmarking within three months before the grant of an award.
This exemption requires the earmarked shares to be delivered on the same day as an award vests, otherwise a tax charge could apply. This means it is important that shares can be delivered on the day of vesting.
Hedging of deferred remuneration
There is an exemption for the earmarking of money or assets for an award of deferred remuneration. This has similar requirements to those described above for share awards but the vesting date must not be more than five years after the grant date. The main additional requirements are:
- if the remuneration was provided to an individual on the award date, instead of deferred, then it would be subject to income tax; and
- the earmarked money or assets must represent the deferred remuneration and nothing else.
Approved share plans
Steps taken under HMRC approved plans, including EMI options, are exempt from the legislation, including arrangements involving the holding and delivery of shares by employee benefit trusts (EBTs) for the purposes of an approved share plan. A single EBT can be used for multiple plans – there is no need to have a specific EBT for an approved plan. However, the number of shares which can held by an EBT for this purpose must not exceed the maximum number of shares which might reasonably be expected to be required for that purpose over the following ten years.
Cashless exercise
The legislation creates a tax charge for many types of employee loans. However, the legislation contains an exemption for short-term loans made to facilitate the exercise of share options. The loan must be repaid within forty days from when the loan is made.
Hedging of awards and options for exit events
There are exemptions from tax charges for earmarking which are similar to those above but apply where a trading company (or its holding company) hedges awards or options for vesting on the occurrence of an exit event. While there is no time limit on the vesting of these awards, the vesting can only occur on an IPO, a sale of either the company or its business/assets, on a winding up of the company or if a person who controls the company ceases to do so.
Outstanding Issues
There remain several areas of uncertainty with the guidance and the legislation, including:
- where more than one exemption applies, can the most favourable exemption be used?
- does the vesting date for a share award have to be a fixed date in order to come within the statutory exemption, and can that date be deferred if it is delayed for a regulatory reason, for example, because of Model Code restrictions?
The final guidance is due to be published later in the Autumn, although HMRC has indicated that it is unlikely to be significantly different to the latest guidance. We hope, however, that it will address some of the remaining areas of uncertainty.
The National Insurance regulations for the disguised remuneration legislation have recently been published in draft but are not yet finalised.
Please contact your usual Hewitt New Bridge Street adviser if you would like to discuss the points raised in this briefing.
This briefing is intended to highlight issues and not be comprehensive, nor provide specific advice. Aon Hewitt Limited does not accept nor assume any responsibility for any consequences arising for any person as a result of them using or relying on the information contained in this briefing.
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