Tax-advantaged share scheme simplification: HMRC response to OTS

Practical Law UK Legal Update 2-520-1059 (Approx. 9 pages)

Tax-advantaged share scheme simplification: HMRC response to OTS

by PLC Share Schemes & Incentives

Background

On 6 March 2012, the Office of Tax Simplification (OTS) published its final report on the first phase of its review of UK taxation and employee share schemes, looking at tax-advantaged share schemes, that is, company share option plans (CSOPs), SAYE option schemes, share incentive plans (SIPs) and enterprise management incentives options (EMI options). The OTS report made a number of recommendations for streamlining and simplifying the tax rules applicable to tax-advantaged schemes (mostly the HMRC-approved schemes, rather than EMI options) including:

Moving from pre-approval (by HMRC) of CSOPs, SAYE option schemes and SIPs (approved schemes) to a self-certification regime.
Further investigation as to whether CSOPs remain relevant for UK business and should be retained.
If CSOPs are retained, amalgamating the CSOP and EMI options rules, but retaining more generous EMI limits for smaller companies.
Simplifying qualifying conditions and leaver tax rules.

For more information, see Legal update, OTS publishes report on tax-advantaged employee share schemes.

HMRC response and consultation

On 27 June 2012, HMRC published its response to the OTS proposals for tax-advantaged schemes (HMRC report), for consultation. The HMRC report seeks evidence and views on issues relevant to how (and in some cases whether) to proceed with various OTS (and government) recommendations.

Responses should be submitted to HMRC's Employee Shares and Securities Unit (at its London office, or by e-mail) by 18 September 2012.

Significant elements of the HMRC report are summarised in the following sections.

The HMRC report includes chapters (discussed in the sections below) that focus on:

Significant OTS proposals that have been accepted. To assist in designing the detailed implementation of these, further views and evidence are sought. For more information, see OTS recommendations to be implemented: consultation to shape detailed proposals.
OTS proposals that will be considered further. To assist with that process, HMRC seeks additional views and evidence. For more information, see OTS recommendations under consideration: consultation on impact, cost and benefits.
The future of CSOPs (see Consultation on the future of CSOPs).
OTS proposals:
- that will or may be considered further in future but that are not subject to consultation now (see OTS recommendations that will (or may) be considered further: no consultation at this stage);
- that the government has rejected but for which it suggests an alternative (see Consultation on government alternative to OTS recommendation: harmonisation of approved scheme good leaver rules); and
- that have been rejected (see Rejected OTS recommendations).

OTS recommendations to be implemented: consultation to shape detailed proposals

Chapter 2 of the HMRC report deals with three OTS proposals accepted by the government, for which views and evidence are sought to develop detailed proposals. The government plans to implement these recommendations "no later than 2014". They are considered further in the three sections immediately following.

Replacement of prior approval by HMRC with company self-certification

The government plans to move away from the current labour-intensive approval process, to self-certification by the company establishing the scheme (for an impression of the current approval process for CSOPs and SIPs, see Checklists, Company share option plans (CSOPs) - setting up a CSOP and the initial grant of options and SAYE option schemes - setting up a scheme and the initial grant of options). However, the government is conscious that these self-certification arrangements must be designed carefully to appropriately protect businesses, employees and the Exchequer.

The HMRC report lists (at paragraphs 2.6 and 2.7) requirements that the government believes self-certification arrangements must satisfy, and issues on which views and evidence would be welcome, including:

Appropriate HMRC powers to enquire into scheme operation and to recoup tax and apply penalties (with appropriate safeguards). (This point is raised only in the list of requirements for the new arrangements, not the list of items on which views are sought.)
Features of approved schemes requiring further clarity or guidance, to enable informed self-certification.
Practical issues that self-certification could present for businesses.
Appropriate safeguards for businesses and employees, to protect them and provide tax certainty.
Possible advance clearance or assurance procedures, without resurrecting prior approval.
Necessary ongoing information requirements.
Costs or savings for businesses.

[PLC comment: This seems likely to be a major change for approved scheme practitioners, who will be concerned to secure effective and workable self-certification arrangements.

They may also be concerned about the possible impacts on their businesses, including:

Potential changes to the risks for advisers arising from scheme establishment, and consequently to the fees that they need to charge.
The possibility that self- certification may discourage companies from adopting approved schemes, at least temporarily, unless there are clear safeguards for employers for changed or unknown levels of risk. For example, companies may be concerned about the possible recovery from the employer by HMRC (and perhaps not so easily from employees by the employer) of historic tax relief should a self-certified scheme be disqualified by HMRC after running for some time.]

Repeal of restrictive requirements

The government intends to remove or modify unnecessarily prescriptive requirements as to the operation of tax-advantaged schemes (and not only approved schemes), but will keep those it considers necessary. The HMRC report includes a brief list (at paragraph 2.9) of issues on which views and evidence would be welcome, including:

Possible relaxation of current requirements to provide scheme participants with information.
Any other operational or administrative requirements that could be updated.
Costs or savings for businesses.

Replacement of "neither essential nor reasonably incidental" approved scheme restrictions with appropriate purpose requirements

All types of approved scheme must not include features neither essential, nor reasonably incidental, to the provision of shares or share options to employees as benefits. The HMRC report states that the purpose of these restrictions is to ensure effective targeting of tax advantages, but notes the OTS comment that they are perceived as confusing and not necessarily aligned with companies' commercial objectives in establishing approved schemes.

The government plans to replace these provisions, and seeks views and evidence on an alternative "appropriate purpose test or framework" to provide both:

Certainty for businesses in the self-certification context.
Safeguards against abuse or poorly targeted tax advantages.

(Paragraph 2.13 of the HMRC report.)

[PLC comment: This is probably necessary for reasonable certainty in a self-certification context and is likely to be welcomed by approved scheme practitioners and companies. It has sometimes been a frustrating (and time-consuming) feature of the HMRC approval process that HMRC and share schemes advisers can differ markedly as to whether a proposed scheme provision is, in an adviser's view, uncontroversial, widely-used, unabusive and commercially justifiable, or, in HMRC's view, not essential or reasonably incidental.

There is a marked contrast between approved schemes and EMI options. The EMI legislation includes a statutory requirement that options be granted for commercial reasons to recruit or retain employees and not for tax avoidance, although this is also set in the context that only smaller companies with a restricted range of trading activities can qualify to grant EMI optoins. We have the impression that HMRC rarely invoke this to deny EMI option status and there is little evidence that it has been abused.]

OTS recommendations under consideration: consultation on impact, cost and benefits

Chapter 3 of the HMRC report lists OTS recommendations that the government may take forward, seeking views and evidence for most of these recommendations about:

Whether it would achieve significant simplification.
Potential impacts.
Potential costs or savings.
Its interaction with the move to self-certification for approved schemes (see Replacement of prior approval by HMRC with company self-certification).

The OTS recommendations subject to further consultation and consideration are:

Alignment of provisions for the favourable tax treatment of retirees under the different approved schemes (for more information about these provisions, see Practice note, Age discrimination and employee share schemes: Meeting statutory requirements). *
Possible reforms of the tax treatment of approved scheme participants and employers on, or following, cash takeovers of the company whose shares are used in the scheme. Here SIPs present particular difficulties, including unexpected secondary (employer) class 1 National Insurance contributions (NICs) liabilities that cannot be recovered from, or transferred to, participants. *
Abolition of employee material interest restrictions for SAYE option schemes and SIPs, and their retention for CSOPs and EMI options, but aligned at the higher EMI option limit (30% or less) (for more information, see Practice note, Material interest rules for tax-favoured share incentives). *
Abolition of the limitations on the restrictions to which shares may be subject if used in approved schemes (for more information, see Checklists, Statutory requirements for CSOP shares and Statutory requirements for SAYE option scheme shares).
In addition to the questions listed at the beginning of this section, for this recommendation the HMRC report asks:
- what types of currently prohibited restriction might be applied by companies if this change proceeds; and
- what safeguards would be required to ensure employees receive a meaningful stake and are treated fairly, and to prevent significant new burdens or costs, and risks of abuse. *
Repeal of SIP provisions relating to transfers of shares from QUESTs, which the OTS considers redundant.
Rather than the questions listed at the beginning of this section, the HMRC report asks whether this might have any undesirable impacts.
Reform of the rules about the determination of numbers of SIP partnership shares to be awarded where there is an accumulation period, which lead to some uncertainty and potential employer costs. *
Relaxation of the time limit for penalty-free payment of PAYE on shares leaving a SIP early.
In addition to those listed at the beginning of this section, the HMRC report includes questions about the practical and timing issues arising with the operation of PAYE in this context and the modes of communication used with employees on SIP shares leaving the plan early.
Abolition of the cap on SIP dividend reinvestment.
In addition to the questions listed at the beginning of this section, the HMRC report requests further evidence as to the number of SIP participants who would benefit from this change. *
Abolition of the seven year savings period, one of the alternatives available for SAYE option schemes.
In addition to the questions listed at the beginning of this section, the HMRC report requests further evidence as to the number of SAYE participants who would be affected by this change. *
Expansion of the circumstances in which SAYE savings can be made other than from salary (at present this can be done in limited circumstances, for example when on maternity leave or, in the case of a reservist, when called up for military service).
In addition to the questions listed at the beginning of this section, for this recommendation the HMRC report asks:
- would the OTS recommendation increase (or otherwise affect) the risk of SAYE savings contracts not being fulfilled and how many employees might be affected by this; and
- what additions to the current exceptions would be useful, and if possible, how many employees would be affected in each case.
Extension of the time limit for preservation of full EMI tax relief on exercise of EMI options from 40 days to six months (for more information about EMI disqualifying events, see Practice note, EMI (enterprise management incentives) options: Disqualifying events that restrict EMI tax advantages). *

*: For these recommendations, if the government decides to proceed, it proposes to publish draft clauses in autumn 2012 and aim to legislate in 2013.

Consultation on the future of CSOPs

The OTS recommended further investigation as to whether CSOPs remain relevant for UK business, given the level of the CSOP individual limit and the difficulties that many private companies have in qualifying to use them. The government accepts this recommendation and Chapter 4 of the HMRC report asks for any new economic evidence on whether CSOPs, as currently used:

Have a positive effect on productivity and growth.
Address market failures and support government objectives in a cost-effective and targeted manner, justifying their support through the tax system.

OTS recommendations that will (or may) be considered further: no consultation at this stage

Chapter 5 of the HMRC report deals (amongst other things) with three OTS proposals that will or may be considered further in future work, and for which no views or evidence are currently sought from consultation respondents. These are:

Move to:
- a single annual return for all types of tax-advantaged schemes;
- online filing for share plan returns and scheme documents; and
- ultimately, real time reporting for share schemes.
The government will consider these points further as it develops and consults on approved scheme self-certification arrangements (see Replacement of prior approval by HMRC with company self-certification).
Merger of CSOPs (if retained) with EMI options.
The government may consider this further following a decision about whether to retain CSOPs (see Consultation on the future of CSOPs).
The Department for Business, Innovation and Skills (BIS) should consider the possible cost to smaller companies of engaging an approved savings carrier to operate an SAYE option scheme as part of its review into widening employee ownership among smaller private companies.
This is noted for further consideration by BIS.

Consultation on government alternative to OTS recommendation: harmonisation of approved scheme good leaver rules

Chapter 5 of the HMRC report also addresses the approved scheme provisions for favourable tax treatment of participants who leave for certain good leaver reasons before the minimum vesting period ends. The OTS recommended that instead of the current approach of specifying favourable treatment for certain good leavers, the legislation should have a presumption that all leavers are good other than specified bad leavers (those who resign voluntarily or are dismissed "with cause").

To ensure effective targeting of tax advantages, to protect the Exchequer and to guard against abuse, the government does not accept this recommendation. However, the government does accept the OTS' points about the potential complexity caused by the differences in this regard between approved scheme types.

The government proposes to harmonise the early good leaver provisions for all types of approved scheme, moving them all (broadly) to the position for SIPs, which is generally the most favourable of the three regimes. However, it is proposed that including good leaver provisions in CSOPs (if these are retained) will remain optional (that is, at the choice of the establishing company when drafting the scheme). In respect of this proposal, the HMRC report seeks views and evidence on:

The extent of the simplification this would achieve.
Potential costs and savings for businesses and individuals.
The impact on the number of SAYE and CSOP early good leavers.

Rejected OTS recommendations

Chapter 5 of the HMRC report lists the following OTS recommendations that will not be taken forward:

Repealing the additional conditions that must be met by companies with more than one class of shares if they are to adopt SAYE option schemes or CSOPs.
Allowing associated companies of the company establishing the scheme (those that are subsidiaries of the issuer of the shares used in the scheme, but not subsidiaries of the company establishing the scheme) to participate in tax-advantaged schemes.
Reduction to three years in all cases of the holding period after which SIP shares can be taken out of a SIP tax-free.
Removal of EMI working time requirements for employees other than directors.
Removal of certain excluded activities from the EMI option trading activities requirements.

Source

HMRC: Consultation: OTS report on tax advantaged employee share schemes, 27 June 2012.

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