Office of Tax Simplification - Proposals for unapproved share schemes and employee trusts

The Office of Tax Simplification (OTS) yesterday published its final report on tax changes to unapproved employee share arrangements, including employee trusts.

Two key recommendations are:

Private companies

The changes here are not likely to affect when employees buy shares at market value, whether a company is up and running and the shares have real value or the company is a start-up.

However, at the moment when employees acquire shares in private companies on favourable terms - either for free or at a discount (or under an employee share option) - they usually have to pay income tax (and often NICs) on the value of the shares less what they have paid for them. This is the case even if they cannot sell the shares, although HMRC approved schemes improve the position. In short, employees have to find cash to pay the tax as well as any exercise or acquisition price.

The OTS is proposing that going forward shares are divided into "marketable" and "non-marketable" shares.

For non-marketable shares (which will be the case with most private companies) the default position would be that income tax and NICs are only payable when the shares become marketable or are sold (whichever is the sooner). When that happens, the amount of income tax would be on the value of the shares at that point. With a rising share price, this could mean more tax becoming payable than under current arrangements, although on the plus side tax would only be payable if and when the shares could be sold for cash to pay the tax.

Employees and companies could still chose to pay tax on the date the shares are received if they want, with no further income tax or NICs payable. In practice, most share acquisitions at market value are also likely to continue to be subject to these elections. This is precautionary: this is just in case tax is payable so as to minimise the tax due by reference to the expected lower value at that point rather than when the shares are sold.

Employee trusts

Although the OTS uses a wider term "employee shareholding vehicle", the OTS is proposing a significant simplification of rules for employee trusts (also known as EBTs) which hold shares. This is part of a co-ordinated approach with other parts of Government.

The proposals would remove many of the tax traps which can bedevil even quite innocent use (including when private companies makes loans to their EBTs) and include a proposal to have a set of model rules that the trust arrangements will have to comply with. This trust would need to be UK resident but if the other proposals go through, many of the tax reasons why companies use offshore rather than UK trusts for their EBTs may fall away, although offshore trusts still have many other advantages. Any tax law changes would also need to be made in conjunction with other proposals - including on company law and regulatory issues.

The recommendations make clear though that the proposal is principally designed to cater for an employee trust which is intended regularly to transfer shares to employees. It may not be appropriate as a model for employee trusts which are intended to hold significant proportions of a company's shares as a long-term or even indefinite investor, which is a separate Government initiative. However, the OTS accepts that many of its recommendations for the "employee shareholding vehicle" would be equally applicable to this type of trust.

Other proposals

Other proposals include:

• simplifying the taxation of share gains for internationally mobile employees
• reducing the Form 42 reporting requirements
• giving longer deadlines for PAYE obligations where they relate to shares
• removing the draconian charge which can apply where employees do not suffer a PAYE charge where shares are received, yet should have done so (particularly relevant for expats where a UK tax charge was not appreciated at the time), and
• improving HMRC valuation processes, including more pre-transaction assistance and more flexibility for unquoted companies.

Any action in this area will be a long time coming, however. Before any changes occur, the Government has to respond to these recommendations (possibly in the March 2013 Budget) and then consult on those proposals it intends to take forward. The earliest legislation is likely to emerge is 2014. However, at the very least a useful debate has now formally been commenced.

Click here for a link to the report.