2013 Budget: corporation tax relief for employee share acquisitions

Practical Law UK Legal Update 5-525-3160 (Approx. 5 pages)

2013 Budget: corporation tax relief for employee share acquisitions

by PLC Share Schemes & Incentives

Background

Part 12 of the Corporation Tax Act 2009 (CTA 2009) provides corporation tax (CT) relief in respect of employee share acquisitions. The relief is available to the relevant employing company, as a deduction from profits, for an amount equal to the gains the employee makes in respect of the shares acquired (broadly, the value of the shares received less any amounts paid for them).

Part 12 of the CTA 2009 (Part 12) provides that where CT relief is available under Part 12, no other deduction in respect of expenses that are directly related to the provision of the shares is allowed (section 1038, CTA 2009). These expenses include any amount payable by an employing company in relation to the participation of the employee in an employee share scheme.

Certain expenses, however, are not disallowed, including:

The costs of setting up an employee share scheme. (These costs would usually not, however, be deductible under general principles, as they are likely to be capital in nature.)
The costs incurred in administering the scheme.
The costs of borrowing for the purposes of the scheme.
Fees, commission, stamp duty reserve tax and "similar incidental expenses of acquiring the shares".

(Section 1038, CTA 2009.)

These expenses will therefore be deductible, in so far as the expenses are deductible in accordance with general principles (in particular, whether the expense is incurred wholly and exclusively in connection with a company's trade, and whether the expense is revenue or capital in nature).

The effect of section 1038 of the CTA 2009 is to exclude other types of CT deduction that otherwise might be available, such as a deduction for accounting costs or costs recharged from an employing company to a parent company whose shares are used for the purposes of a share scheme.

Draft legislation to amend Part 12 of the CTA 2009

On 20 March 2013, as part of the 2013 Budget, HMRC published draft legislation to amend Part 12 of the CTA 2009 in order to clarify when a CT deduction is available in respect of employee share acquisitions. The draft legislation replaces the existing section 1038 of the CTA 2009 and adds a new section 1038A, which addresses the availability of CT deductions for share options when shares are not acquired pursuant to the option. The explanatory note that accompanies the draft legislation comments that some companies have argued that a CT deduction can be obtained in respect of accounting expenses that recognise share-based payments, either in addition to the Part 12 CT deduction or in respect of options where shares are not ultimately acquired pursuant to the option.

The proposed new sections 1038 and 1038A are designed to put beyond doubt the government's position that CT deductions are not available for accounting expenses where shares are not acquired by an employee, or in addition to the Part 12 CT deduction.

New section 1038 disallows deductions relating to matters connected with the provision of shares

The revised section 1038 is broader than the current section 1038. In particular, it:

Excludes a CT deduction in relation to the provision of the shares or to any matter connected with the provision of the shares. (This is considerably broader than the current section 1038, which excludes a CT deduction for expenses directly related to the provision of the shares.)
Excludes deductions in relation to an option, or to any matter connected with an option.
Makes it clear that it is irrelevant if an accounting period for which a CT deduction is sought falls wholly before or after the date on which the shares are acquired.
Provides specifically (as with the current section 1038) that amounts paid or payable by an employing company in relation to the participation of an employee in an employee share scheme are not deductible.
Excludes the same limited deductions from the general prohibition (such as the costs of administering the scheme) as the existing section 1038.

The draft legislation also adds a new section 1038A. Section 1038A will apply to employee share options granted in accordance with the conditions set out section 1015 (a) to (c) of the CTA 2009 (which require an option to be granted by an employing company in relation to a qualifying business in order to be eligible for CT relief). It will also apply to options received in connection with options that were originally granted in accordance with the section 1015 conditions, such as replacement options granted on a takeover.

New section 1038A disallows deductions in connection with options where shares are not acquired

Section 1038A(2) disallows a CT deduction, in any accounting period, in connection with the option or any matter connected with the option unless shares are actually acquired pursuant to the option, subject to certain exceptions. In particular, section 1038A(4) provides that a deduction is not available for amounts paid or payable by the employing company in relation to the participation of an employee in an employee share scheme. Exceptions to the general rule that a CT deduction is disallowed in relation to an option where no option is acquired (in section 1038A(5)) are identical to those set out in the existing section 1038(4) (which are also reproduced in the new draft section 1038(6)).

Section 1038A(7) provides that section 1038A(2) does not operate to disallow deductions for:

Amounts on which the employee is subject to a charge under the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), or would have been had they been a UK employee.
If the employee has died, amounts on which the employee would have been subject to income tax under ITEPA 2003, had the employee been alive.

Possible income tax charges that could arise under ITEPA 2003 in relation to an option where shares are not acquired pursuant to the option include income tax on a payment made in consideration of the release of the option (cash cancellation payments) or a payment or benefit received in connection with not exercising the option. Excluding costs like this from the general prohibition on a CT deduction does not necessarily mean that a CT deduction will be available. Whether or not a CT deduction is available in connection with such costs will depend on whether the expenditure is deductible under general principles.

New legislation applies from 20 March 2013

The new section 1038 applies to disallow deductions for any accounting period ending on or after 20 March 2013, regardless of when the relevant shares are acquired except that, for an accounting period that begins before 20 March 2013 but ends after that date, it will not deny a deduction arising in connection with shares acquired before 20 March 2013.

Section 1038A (that relates to options) applies to accounting periods ending on or after 20 March 2013, regardless of when the option was granted. However, for a company which has an accounting period spanning 20 March 2013, the new section 1038A will not operate to disallow a deduction where both of the following took place before 20 March 2013:

The option was granted.
An event occurred, as a result of which shares cannot be acquired pursuant to the option (such as the lapse or cancellation of the option).

Comment

HMRC's position is that the legislation in Part 12, as currently drafted, will usually deny corporation tax relief for deductions relating to accounting expenses, and HMRC will continue to challenge any deductions that are claimed on this basis. In general, most practitioners and commentators agree, and the prevailing view is that, where a Part 12 deduction is available, additional or alternative deductions based on accounting expenses, or intra-group recharges are not available. However, the new legislation puts the matter beyond doubt, by broadening the scope of the existing section 1038.

Sources

HMRC: 2013 Budget: Corporation tax relief for employee share acquisitions: draft legislation and explanatory note, 20 March 2013.

HMRC: 2013 Budget: Tax Information and Impact Note, Corporation tax deductions for employee share acquisitions.

2013 Budget: corporation tax relief for employee share acquisitions | Practical Law