Tax and national insurance rates may be rising and HMRC may be cracking down on avoidance schemes but there are legitimate ways to achieve tax efficiencies.
1. Pay bonuses early
Many companies are considering bringing forward the payment of bonuses which would have fallen to be paid after 6 April 2010 and therefore have attracted the higher income tax rates. This is attractive as it is simple. Shareholders will be concerned that performance periods being rewarded have been completed rather that bonuses being paid partly on guess work. It is also appropriate to ensure that any overpayment based upon unaudited results can be clawed back once audited figures are available.
There may also be scope to consider exercising options before 6 April 2010 to benefit from the current lower tax rate of 40%. However this will depend entirely upon the individual circumstances and may not be appropriate in a number of situations, particularly where it is envisaged that a company’s share price might benefit from a substantial increase in the future.
2. Salary sacrifice into pensions and other tax efficient benefits
For those earning £100,000 and over it makes good sense to consider salary and bonus sacrifice arrangements. The employee simply gives up the right to part of his or her cash remuneration under his or her contract of employment in return for the employer’s agreement to provide the employee with some form of tax efficient non-cash benefit.
“Salary sacrifices” can be made into many forms of tax efficient benefit, for example, child care vouchers which are popular with employees with young families or pensions, which is examined further below.
Advantages to employer
If the salary sacrifice is made in return for the employee receiving a benefit which does not attract national insurance contributions (“NICs”) liability the employer contributions will be saved. These currently amount to 12.8% (assuming there is no discount for contracting out of the second state pension). This rate is due to rise with effect from 6 April 2011 to 13.8%.
The saved contributions can be applied to defray the costs of setting up the arrangement, to increase the benefit provision to the employee, or to reduce the employment overhead for the employer. Quite what scope there is depends upon the aggregate amount of salary sacrificed under the arrangement which will dictate the amount of employer’s NIC savings.
Advantages to employee
The employee is able to save the amount of employee’s national insurance contributions and apply the value of these to their chosen benefit. Some employers also pass on some of their savings to benefit the employee.
By reducing the employee’s gross wages this can affect mortgage applications and entitlement to state benefits. The employer should advise the employees of these consequences. Further information of the effect in relation to state benefits is available on HMRC’s website (see link in Resources below).
For employees on maternity leave sacrifice of cash remuneration into benefits can mean that the employer retains an obligation to fund the benefit whereas there would be no obligation to pay salary during the period.
Salary Sacrifice into a Registered Pension Scheme
The amount of salary sacrificed can be paid by the employer into a registered pension scheme operated by it for its employees or into the employee’s personal scheme. However, anti-avoidance provisions apply with effect from 22 April 2009 for the tax years 2009/10 and onwards for those earning £130,000 and over, seeking to make salary sacrifice into pensions – see Resources: “UK income tax and social security – the new realities”).
Table 1. Comparison of net benefit delivered by salary against salary sacrificed to pension provision (applying 2009/10 tax and NIC rates –net benefits of sacrifice will increase with new income tax rates in 2010/11 and higher NICs in 2011)
|Net salary sacrifice of £100||Gross tax free sum benefit
(employer’s NIC saving)
Registered Pension Scheme
|Gross tax free sum benefit
(employer’s NIC saving)
Registered pension Scheme
|Basic rate taxpayer (20%)||£145
|Higher rate taxpayer||£170
|Higher rate tax payer (£100,000 – £112,950)||£256
All numbers rounded
3. Tax efficient employee share plans – is there a better time?
Some employee share plans are able to ensure that all or part of the value delivered under them is taxed as capital gain, currently at 18%, rather than being subject to income tax at 40% for higher rate tax payers (and rising to up to 60% in April 2010 for those earning over £100,000 per annum). Some can deliver national insurance and corporation tax savings for the employer.
Tax efficient share plans include those which are approved by HM Revenue & Customs (EMI Options and Company Share Options) as well as plans which, while not being specifically approved by HMRC, still carry significant tax benefits if implemented appropriately.
No cash cost
Significantly, delivery of reward in the form of awards over new shares does not bear a cash cost for the company while many plans will offer a corporation tax deduction to employers.
Salary sacrifice into share plans
Many companies are allowing employees to sacrifice entitlement to their salary or bonus in return for a grant of a nil cost option over share with a commensurate value. The employee thereby defers an income tax and national insurance charge until the time when he or she exercises the option. By utilising HMRC approved share plans, whether or not a lower tax charge is achieved by deferral, any rise in value of the shares may be taken as capital gain and taxed at 18% (current rate), with the benefit of the annual exemption, where this is available.
The employer stands to benefit by reducing demand on its cash flow and by having a potential influx of subscription monies on exercise of the options.
For those who consider that their share prices can only rise as the UK and the wider world moves towards better economic times such arrangements can be attractive.
4. Joint share ownership
For both listed and private companies shared growth or joint share ownership arrangements are very appealing from a tax perspective. Under such arrangements, the employee acquires a contractually defined beneficial interest in shares and simultaneously the trustees of an employee benefit trust acquire a different contractually defined beneficial interest in the same shares.
The employee will acquire a smaller interest initially in the current value of the shares but will have the right to all, or a certain percentage of, future growth in value of the shares, or all future growth
Since the employee benefit trust acquires a greater interest of the current value of the shares, the employee’s up front acquisition cost for his or her interest in the shares is generally fairly low for tax purposes as the right to future growth has only ‘hope’ value.
Such arrangements can be extremely tax efficient when structured and implemented correctly.
HMRC appears to agree with the tax treatment of these arrangements absent any contrived avoidance arrangements.
5. Growth shares
Growth shares involve the creation of a new class of shares in a company which affords the shareholder only very limited rights. As such, the shares have a low market value at the time they are acquired and any income tax charge on acquisition is minimised.
Holders of these “growth” shares are only allowed to participate in the growth in value of the company over defined thresholds after the shares have been issued. Any such growth in value is subject only to capital gains tax and not income tax.
As growth shares require a new class of share to be created, these arrangements are not suitable for use by publicly listed companies.
6. Nil paid shares
Again, for private companies, when structured correctly, nil paid share arrangements can offer significant tax benefits to employees.
As the employee obtains ownership of the shares immediately, any growth in value of the shares is taxed only as a capital gain rather than as income.
There will be no charge to income tax at the time when the shares are acquired provided they are acquired at their unrestricted market value. A smaller charge to income tax will arise on the amount which remains unpaid on the shares, as a “notional loan”.
Employer and employee NICs are not chargeable on nil paid shares, although, in most circumstances both employer and employee NICs will arise on any charge to income tax on termination of the notional loan.
In contrast to most other tax efficient incentive arrangements, however, corporation tax savings are not available for the employer when using nil paid share arrangements.
We would be pleased to meet with you to discuss how incentive arrangements can work more efficiently for your company.
If you are interested in taking up either offer, without any obligation, then please get in touch.