In February 2016, the UK tax authorities (HMRC) announced that they will be cracking down on certain types of remuneration arrangements which seek to convert what would otherwise be taxable employment income into capital gains.
Taxation of employment income
UK resident employees receiving a cash bonus would ordinarily be subject to income tax and social security contributions at a marginal rate of up to 47% for those subject to tax at the highest rate. However, UK capital gains tax is only payable at a rate of 28% for such tax payers, and there are also certain tax free allowances that individuals with capital gains may take advantage of. This provides a clear incentive for employers to structure arrangements that fall within the capital gains tax regime.
Contract for differences schemes
The arrangements HMRC are targeting typically involve an employee acquiring rights under what is known as a contract for differences (CFD) (sometimes known as ‘Growth Securities Ownership Plans’). These types of contracts entitle the employee to receive a cash payment at a pre-determined date provided a pre-determined hurdle is achieved (which may be linked to company performance or other measures).
In order to qualify as a CFD, the employee must pay a premium for entering into the arrangement and could potentially be required to make a payment to the counterparty if performance is below a specified threshold. The threshold is usually set at such a level so that it is very unlikely a payment by the employee will be required. Any payment by the employee would, in any case, be much less than what the employee could potentially receive.
The effect of these kinds of schemes is to provide a similar benefit to a cash bonus, but as a CFD is a ”security” for tax purposes, it is argued that the payment is within the capital gains rather than income tax regime.
Opinion of the UK tax authorities
The announcement states that it is HMRC’s view that these schemes do not work, and that any payments under such schemes should be taxed as employment income and subject to PAYE income tax and employer and employee National Insurance Contributions (NICs). It further states that it will act swiftly and rigorously to challenge such arrangements, and offers employers the opportunity to settle any outstanding income tax and NICs due in connection with such schemes, together with interest.
HMRC does not go into any technical analysis as to why the schemes do not work, so it may be that some employers will decide to challenge this view in the courts.
How does this affect other share incentive arrangements?
CFD schemes are considered to be one of the more aggressive forms of remuneration scheme for converting income into capital, so it is not surprising that HMRC has made this announcement. However, it should certainly not have any impact on more conventional types of share incentive arrangement that take advantage of legislative tax breaks, such as Company Share Option Plans and Enterprise Management Incentive Plans.
It should also not affect what are known as “growth share” or “joint share ownership” arrangements, which seek to give capital gains treatment for shares which have a low acquisition cost for employees.
HMRC have been reviewing these types of arrangements over the last few years, but, at the current time, they seem to accept that they deliver capital gains treatment, provided the shares are valued correctly.
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