Finance Bill 2003: Share Schemes Update

United Kingdom

The Chancellor's speech on Budget Day gave no hint of the fine print and the myriad of changes affecting share incentives which would follow, first in the press releases and subsequently in the Finance Bill. The information below summarises the main proposals, some of which are already in force although the Finance Bill will not receive Royal Assent until late July or early August.

Approved Company Share Option Plans ("CSOPs")

With effect from 9 April 2003:

  • The 'second three year rule' has been removed allowing tax free exercise of a CSOP option within three years of previous tax relieved CSOP exercise;

  • "Good leavers" who exercise options within 3 years of the date of grant can do so without income tax or National Insurance Contributions ("NICs");
  • Other early exercises of approved CSOP options will be treated in the same way as unapproved exercises ie income tax arising will be collected through PAYE and any gain on exercise will be liable to NICs;
  • The application process for Inland Revenue approved CSOPs has been simplified. Schemes will generally be operative from the date of adoption by the company;
  • Cashless exercise arrangements to fund the exercise price or PAYE and NICs will be acceptable in future if they do not provide a right to receive cash; and
  • Options granted prior to 6 April 1999 have been outside the scope of NICs. If pre-April 1999 options are used to avoid NICs on cash bonuses in future a NICs liability will arise.

SAYE

  • New bonus rates apply to all new sharesave invitations on or after 27 April 2003 as follows: 3 year scheme: 1 month (1.74 per cent) 5 year scheme: 3.7 months (2.34 per cent) 7 year scheme: 7.6 months (2.64 per cent) These rates will be reviewed again with possible new rates being introduced in September 2003.
  • With effect from Royal Assent, option holders will have a right to exercise SAYE options where they lose their job due to injury, disability, redundancy or retirement following a move between associated companies.

CSOP and SAYE

With effect from Royal Assent, it will not be necessary to submit all changes to the Inland Revenue for approval. In future, only changes to key features will need to be approved by the Inland Revenue.

Share Incentive Plans

With effect from Royal Assent:

  • The monthly limit of £125 or 10 per cent of salary has been amended so that an annual limit of £1,500 can be set allowing a lump sum purchase at any time during the year.
  • Participation in two SIPs run by connected companies in the same year will be allowed.
  • The holding period for dividend shares is to be aligned with the holding period for the base shares to which they relate.

Unapproved Schemes

The deadline for employees to refund PAYE and NICs on share option gains to their employers is extended from 30 to 90 days.

The existing limit on the amount of NICs that may be recovered from employees each month which was restricted to the employee's monthly salary is being abolished and the period over which recovery may be made is being extended into the following tax year.

Capital Gains Tax

The decision in Mansworth v Jelley has been reversed so that the base cost is now back to where it was before that case was decided. Where options are exercised on or after 10 April 2003 the base cost of shares:

  • acquired under an approved or EMI scheme where there is no income tax on exercise is the amount paid by the option holder on exercise of the option;
  • acquired under an approved, EMI or unapproved scheme where there is a liability to income tax on exercise is the amount paid by the option holder on exercise of the option plus any amount on which income tax is payable at exercise;

A transferor of existing shares, eg trustees of an employee benefit trust on exercise of an option will be subject to CGT only on the exercise price received.

This also means that trustees of an employee benefit trust who dispose of shares to beneficiaries will be treated as disposing at the option exercise price rather than at the deemed market value.

Statutory Corporation Tax Deduction for the Cost of Share Schemes

Draft legislation published at the time of the Chancellor's Pre-Budget Report on 27 November 2002 has been included in the Finance Bill. It provides:

  • for a corporation tax deduction calculated on the difference between the option exercise price and the market value of the shares at the date of exercise;
  • that the timing of the deduction is linked to the time at which the employee is subject to UK income tax on the shares received or would have been if the option is an Inland Revenue approved or EMI option or if the employee is non-UK resident;
  • that the corporation tax deduction is available to the employer company not the company whose shares are issued;
  • that the statutory deduction is only available in respect of "qualifying shares";
  • that the statutory deduction for contributions to Qualifying Share Ownership Trusts is withdrawn for accounting periods beginning on or after 1 January 2003.

Employee Benefit Trusts

Draft legislation published on 27 November 2002 to counter avoidance of income tax and NICs through the use of EBTs is included in the Finance Bill. The new legislation defers the contributing employer's corporation tax deduction until a payment is made out of the EBT in a form that gives rise to a liability to income tax and NICs.

Shares Acquired by Employees

The tax treatment of shares and securities acquired by employees has been substantially rewritten in Schedule 22 Finance Bill 2003. Some of the major changes are as follows:

  • the exemptions from income tax on the acquisition of shares subject to forfeiture have been narrowed by the removal of the articles of association exemption;
  • an income tax liability will arise where restrictions on shares are varied or removed;
  • new legislation taxing artificial increases or decreases in the value of shares will replace the dependent subsidiaries legislation;
  • options over gilts will be covered as well as options over shares;
  • the scope of the legislation has been extended so that employees who are not resident and/or not ordinarily resident will be affected;
  • more shares will be regarded as readily convertible assets and PAYE will apply in most circumstances;
  • PAYE and NICs rules will be aligned.

For further information, please contact Kate Kelleher (share schemes partner) at [email protected] or on +44 (0) 20 7367 2860.