Recent UK tax developments in share incentive arrangements

The Waterloo case and inter company recharges

In light of a recent Inland Revenue statement published in Tax Bulletin 63, the case of Waterloo plc v CIR and a new statutory corporation tax relief for the cost of employee share schemes (included in this year's Finance Bill) UK and non UK companies operating international share incentive plans should review their inter company recharging arrangements.

UK parent companies who have not charged their non UK subsidiaries or who have made a charge which is not at arm's length in respect of options granted or shares awarded to non UK employees may be taxed as if they have received an arm's length payment.

An inter group recharge paid by a UK subsidiary to its non UK parent for share options granted to its employees is allowable as a deduction for the period in which the recharge is made provided it is calculated on an arm's length basis and it relates only to employees working for UK entities.

The Inland Revenue consider that applying an inter company recharge on the basis of the difference between the market value of shares acquired at the date of exercise and the exercise price is not appropriate. Cost plus and cost sharing arrangements must be based on arm's length cost calculated in accordance with a method acceptable to the Inland Revenue.

Where a non UK parent company is recharging its UK subsidiaries or a UK parent company is recharging its non UK subsidiaries for the cost of employee share incentive arrangements the basis for making the charge should be reviewed to ensure it is not susceptible to challenge by the UK Inland Revenue.

Statutory corporation tax deduction

The introduction of a statutory corporation tax deduction for UK companies and its interaction with inter company recharge arrangements also needs to be considered.

This new relief is available for accounting periods beginning on or after 1 January 2003 where an employee of a UK company acquires shares in another company provided all the requirements for relief are met. The value of the deduction for the UK company is the difference between the market value of the shares at the time they are acquired and the amount payable by the employee.

Interaction of the corporation tax deduction and inter company recharges

The draft legislation provides that where the conditions for relief are satisfied a UK company is not allowed any other deduction for corporation tax purposes for the cost of providing the shares. This means that if there is a recharge by a non UK parent company to its UK subsidiary for the cost of providing the shares, the recharged amount will not be deductible where the statutory deduction is available to a UK subsidiary. If the conditions for relief cannot be satisfied then no statutory deduction will be available under the new legislation, but a deduction for an inter company recharge may apply provided it has been calculated on a basis which reflects the Inland Revenue views set out in Tax Bulletin 63 and summarised above.

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