In the last chapter, we covered the general rules for employment income,
including taxable and exempt benefits.
In this chapter, we first consider the general rules on the tax charges which
may apply if an employer provides shares or share options to an employee.
Next, we consider the special rules where an employee gives up some
employment rights in exchange for receiving shares in the employer company.
Then we look at the rules for tax advantaged share and share option schemes.
Not only are these tax efficient means by which employees can be remunerated
but they also provide a link between remuneration and the company’s
Finally, we look at the rules for lump sums paid to employees, usually on the
termination of the employment.
In the next chapter, we will turn our attention to the self-employed.
|1||Income and income tax liabilities in situations involving further overseas aspects and in relation to trusts, and the application of exemptions and reliefs|
|(c)||Income from employment:||3|
|(i)||Advise on the tax treatment of share option and share incentive schemes, including employee shareholder shares|
|(ii)||Advise on the tax treatment of lump sum receipts|
Share incentives and share options may well feature in a question about employees. You may be required to advise the employer as to which incentive scheme would meet their needs. You need to know the different conditions for each scheme – you will not get any marks for recommending an enterprise management incentive scheme to a company whose gross assets exceed £30 million.
Lump sums are commonly paid on the termination of an employment. You may be required to discuss which elements of a termination package are tax free, and the consequences of the ongoing provision of a benefit.
None of the topics in this chapter were examinable in Paper F6.
1 Shares and share options: general rules
|Where shares or share options are provided to an employee, income tax and/or national insurance contributions may be payable.|
An employer may include shares and share options as part of an incentive package offered to employees. Unless they fall within the special tax advantaged schemes which provide tax reliefs (see later in this chapter) tax charges may arise as described below.
1.2.1 Income tax
The ownership of shares in an employing company may lead to tax charges:
- If a director or an employee is given shares, or is sold shares for less than their market value, the director or employee is treated as receiving specific employment income of the difference between the market value and the amount (if any) which the director or employee pays for the shares.
- If, while the director or employee still has a beneficial interest in the shares, a ‘chargeable event’ occurs, there is a charge on the increase in the value of the interest caused by the chargeable event as specific employment income.
A chargeable event is a change of rights or restrictions attaching to either the shares in question or to other shares which leads to the value of the shares in question increasing, and which takes place while the person concerned is a director or employee of the company within seven years of their ceasing to be one. However, where the change applies to all shares of the same class there is not, in general, a chargeable event.
- If an employee, having obtained shares by reason of being a director or employee, receives any special benefit because of owning the shares, he is taxable under on the benefit as specific employment income unless:
- The benefit is available to at least 90% of persons holding shares of the same class, and
- – The majority of the shares of the same class are not held by directors or employees, or
– The company is employee-controlled by virtue of holdings of the same class of shares.
- If an employee or director receives shares which may later be forfeited, there is no income tax charge when the shares are acquired. There is an income tax charge when the risk of forfeiture is lifted or when the shares are sold, if sooner. The amount of specific employment income will be the difference between the market value of the shares less the cost of the shares.
- If shares received as a result of employment are subsequently converted to shares of another class, there is an income tax charge on conversion on the difference between the market value and cost of the shares.
In the above situations, when the base cost of the shares is being calculated for capital gains tax purposes (see later in this Text) any amount charged to income tax is added to the acquisition cost of the shares.
1.2.2 National insurance contributions
If there is an income tax charge in respect of acquiring shares, Class 1 National insurance contributions (NIC) may also be due. An amount equal to that charged to income tax is treated as ‘earnings’ for NICs. However, this treatment only applies if the shares are ‘readily convertible assets’ eg if they can be sold on a stock exchange.
1.3 Share options 6/13
1.3.1 Income tax
- If a director or an employee is granted an option to acquire shares (ie is given the right to buy shares at a future date at a price set now), then, in general, there is no income tax charge on the grant of the option.
- On the exercise of the option there is a charge as specific employment income on the market value of the shares at the date of exercise minus the sum of what (if anything) was paid for the option and what was paid for the shares. If he assigns or releases the option for money, or agrees (for money) not to exercise it or to grant someone else a right to acquire the shares, he is likewise taxable on the amount he receives minus the amount they paid for the option.
Simon was granted an option to buy 10,000 shares in his employer company in September 2012. The cost of the option was £1 per share. The price at which the option could be exercised was £5.
Simon exercised his option in August 2015, when the shares had a market value of £8.
What is the amount of specific employment income taxable in 2015/16?
|Market value at exercise 10,000 £8||80,000|
|Less price paid for option 10,000 £1||(10,000)|
|price paid for shares 10,000 £5||(50,000)|
|Chargeable on exercise||20,000|
1.3.2 National insurance contributions
If there is an income tax charge in respect of shares options, Class 1 National insurance contributions (NIC) may also be due. An amount equal to that charged to income tax is treated as ‘earnings’ for NICs. However, this treatment only applies if the shares acquired on the exercise of the option are ‘readily convertible assets’ (see above).
2 Employee shareholder shares
An employee may be given shares in exchange for giving up certain employment rights and receive tax advantages in relation to those shares.
2.1.1 Employee shareholder: definition and conditions
An employee shareholder is an individual who works under an employee shareholder employment contract which provides for certain employment rights to be given up in exchange for shares in the employer company.
The employment rights that an employee shareholder gives up include the rights to:
- Unfair dismissal compensation
- Statutory redundancy pay
- Request flexible working or time off to train.
The following conditions must be met for an individual to be an employee shareholder:
- The individual and the company must both agree that the individual will be an employee shareholder.
- The employer must give the individual fully paid up shares in the employer’s company (or employer’s parent company), which must be worth at least £2,000.
- The individual must not pay for the shares in any way other than giving up the employment rights.
- The employer must give the individual a written statement of the particulars of the status of employee shareholder, including, for example, the employment rights that the employee shareholder has given up and whether the shares carry any voting rights or rights to dividends.
- The individual must obtain advice from a relevant independent adviser, such as a lawyer, on the terms and effect of the written statement to help that individual decide whether or not to become an employee shareholder. The company must pay the reasonable costs for that advice, even if the individual decides not to become an employee shareholder. There is no taxable employment benefit (see earlier in this Text) in respect of this payment.
- The individual must wait for seven days from the day after receiving the advice before accepting or rejecting employee shareholder status.
If an employee shareholder disposes of the shares provided by the employer, the employee’s ’employee shareholder’ employment status does not change.
2.1.2 Income tax and national insurance contributions on employee shareholder shares
There is a charge to income tax and, possibly, national insurance contributions on the provision of employee shareholder shares to an employee shareholder as explained in section 1.2 earlier in this chapter.
However, the employee shareholder is deemed to have made a payment of £2,000 for those shares. Therefore, if £2,000 worth of shares are provided to the employee shareholder, there will be no charge to income tax or national insurance. If more than £2,000 worth of shares are provided to the employee shareholder, only the excess over £2,000 will be subject to income tax (and national insurance, if the shares are readily convertible assets – see above).
The deemed payment is usually only available once to an employee shareholder from the same employer.
The deemed payment is not available if the employee shareholder (or by or together with persons connected with that employee) has a material interest (ie >25% of voting rights) in the company at any time in the 12 months before the acquisition of the employee shareholder shares.
Louise started employment with Halo plc on 1 December 2015 and was given 5,000 shares in Halo plc worth £2 each on that date. Louise did not have material interest in Halo plc at any time.
What is the amount of specific employment income taxable in 2015/16 in respect of those shares if:
(a) Louise is not an employee shareholder, or (b) Louise is an employee shareholder?
|(a)||Louise is not an employee shareholder|
|Market value at provision 5,000 £2/Specific employment income||£10,000|
|(b)||Louise is an employee shareholder|
|Market value at provision 5,000 £2||10,000|
|Less deemed payment||(2,000)|
|Specific employment income||8,000|
2.1.3 Capital gains tax on employee shareholder shares
If, when the shares were acquired, their total value was £50,000 or less, any gain on the first disposal of employee shareholder shares by the employee shareholder is exempt from capital gains tax. If the value of the shares exceeded £50,000, only the gain on the first £50,000 worth of shares is exempt.
This amount is based on the unrestricted value of the shares, and takes into account all employee shareholder agreements with the same employer.
The exemption is not available if the employee (or by or together with persons connected with that employee) has a material interest (>25% of voting rights) in the company at any time in the 12 months before the acquisition of the shares.
If a loss arises on the disposal of employee shareholder shares, the loss is not an allowable loss if a gain would have been exempt had it arisen on the disposal.
The following rules for capital gains tax (see later in this Text) are amended in respect of employee shareholder shares:
- No gain/ no loss provisions for disposals between spouses/civil partners do not apply to transfers of employee shareholder shares.
- Share pooling and matching rules do not apply to employee shareholder shares. In addition, if the individual has a mixture of employee shareholder shares and other shares in a company, on a disposal of shares, the individual can decide which of the shares disposed of are to be treated as employee shareholder shares.
- Paper for paper rules do not apply on a takeover of the employer company so there will be a disposal of the employee shareholder shares.
3 Tax advantaged share schemes
|There are a range of tax advantaged share schemes under which an employer may be able to give employees a stake in the business.|
Successive governments have recognised the need to encourage schemes that broaden share ownership among employees or reward personnel. A number of tax advantaged schemes exist. These are detailed in the following sections.
|If you are asked to recommend a tax advantaged scheme ensure that you select one which fits the employer’s requirements.|
Exam focus point
There are four types of such share scheme:
- Schedule 3 save as you earn (SAYE) share option schemes
- Schedule 4 company share option plans (CSOP)
- Schedule 5 enterprise management incentives (EMI) Schedule 2 share incentive plans (SIPs)
The first three listed above involve share options, whereas SIPs involve employees being given shares. The schedule names refer to the relevant schedule in the Income Tax (Earnings and Pensions) Act (ITEPA) 2003.
There are many detailed rules governing these schemes, but in this chapter, the following aspects are considered for each scheme:
- How the scheme operates.
- Taxation implications of grant and exercise of options (where appropriate). These tax advantaged schemes generally allow options to be granted and exercised without income tax and national insurance charges.
- Taxation implications of sale of shares. Generally, the only tax charge is when the shares are sold at a gain and the charge is to capital gains tax (rather than income tax and national insurance).
- Conditions for the scheme. The conditions required by each scheme vary but may relate to the company operating the scheme, the employees participating in the scheme, the shares being issued, and the price at which options can be exercised. In some cases, certain time limits must be met eg shares/options must be held for a certain period.
- Costs of setting up the scheme. Deductions available for the operating company are considered.
SAYE, CSOP and SIP schemes must be registered and self-certified (a declaration made that the conditions are met) by 6 July following the tax year in which the first option is granted or shares awarded.
3.2 SAYE share option schemes 12/11
|A Save As You Earn (SAYE) share option scheme allows employees to save regular monthly amounts for a fixed period and use the funds to take up options to buy shares free of income tax and NIC. Alternatively they can simply take the cash saved.|
3.2.1 How the scheme operates
An employer can set up a scheme, which must be open to all employees (full-time or part-time) and full-time directors, under which employees can choose to make regular monthly investments in special bank or building society accounts called sharesave accounts. Employees can save a fixed monthly amount of between £5 and £500.
The investments are made for three or five years, and a tax-free bonus is then added to the account by way of interest.
At the withdrawal date, the employee may take the money in cash. The employee may alternatively use the money to buy ordinary shares in their employer company, or its holding company, under options granted when the employee started to save in the account.
The price of these shares is fixed by the option and must be at least 80% of the market value at the date the option was granted.
3.2.2 Tax implications of grant and exercise of options
There is no income tax or national insurance charge:
- When the options are granted (ie when the employee starts saving in the scheme),
- While the employee saves money in the scheme, in particular the bonus given by way of interest is tax-free,
- When the options are exercised,
- If the employee decides not to buy shares, but to withdraw the money instead.
3.2.3 Tax implications of sale of shares
There is no income tax or national insurance contributions payable on the sale of shares acquired under an SAYE scheme.
When the shares are sold, any gain is subject to CGT. The cost in the gain calculation is the price the employee paid for the shares.
3.2.4 Conditions for SAYE schemes
To qualify as an SAYE scheme, the scheme must be open to all employees and full-time directors, and on similar terms. Part-time directors may be included, but can be excluded. However, a minimum qualifying period of employment (of up to five years) may be imposed, and there may be differences based on remuneration or length of service.
3.2.5 Costs of setting up SAYE schemes
The costs of setting up an SAYE scheme incurred by a company are deductible in the accounting period in which they are incurred.
3.3 Company share option plans (CSOP) 12/12, 12/14
There is no income tax or NIC on the grant of a Company Share Option Plan (CSOP) option. There is also no income tax or NIC on an exercise taking place between three and ten years after the grant. Only CGT will apply to the profit on disposal of the shares.
3.3.1 How the scheme operates
Under a CSOP scheme, which can be restricted to selected employees and full-time directors, an employee is granted options to buy shares. Options must be exercised between three and ten years from grant to achieve the beneficial tax treatment (see below). An employee can be granted options over shares up to the value of £30,000 (at the date of grant).
3.3.2 Tax implications of grant and exercise of options
There is no income tax or national insurance on:
- The grant of an option under a CSOP, nor
- On the profit arising from the exercise of an option under a CSOP between three and ten years after the grant.
The tax exemption is lost in respect of an option if it is exercised earlier than three years or later than ten years after grant.
The three year waiting period does not apply when personal representatives exercise the options of a deceased employee within twelve months of death (but the ten year rule still applies).
If the options are exercised before three years after the grant, they will remain tax exempt if the exercise (and exit from the scheme) arises due to certain circumstances which include:
(a) cessation of employment due to the injury, disability, redundancy or retirement of the employee, (b) a cash takeover of the company which results in a forced exercise of the options.
3.3.3 Tax implications of sale of shares
There are no income tax or national insurance consequences of the sale of shares acquired under a CSOP.
When the shares are sold, any gain is subject to CGT. The cost in the gain calculation is the option price paid by the employee to acquire the shares.
3.3.4 Conditions for CSOPs
To qualify as a CSOP, the scheme must satisfy the following conditions:
- The shares must be fully paid ordinary shares.
- The price of the shares must not be less than their market value at the time of the grant of the option.
- Participation in the scheme must be limited to employees and full-time directors, but the scheme need not be open to all employees and full-time directors.
- No options may be granted which take the total market value of shares for which an employee holds options above £30,000. Shares are valued as at the times when the options on them are granted. Options must not be transferable.
- If the issuing company has more than one class of shares, the majority of shares in the class for which the scheme operates must be held other than by:
- Persons acquiring them through their positions as directors or employees (unless the company is an employee controlled company)
- A holding company (unless the scheme shares are quoted)
- Anyone who has within the preceding 12 months held over 30% of the shares of a close company which is the company whose shares may be acquired under the scheme, or which controls that company either alone or as part of a consortium, must be excluded from the scheme.
3.3.5 Costs of setting up CSOPs
The costs of setting up a CSOP incurred by a company are deductible in the accounting period in which they are incurred.
|CSOPs were tested in December 2012 Qu 1(a). Flame plc group. The examiner commented that ‘In order to do well, candidates needed to slow down for a moment and make sure that they were about to write about the correct scheme. They then needed to ensure that they addressed all of the issues set out in the question. The majority of candidates did both of these things and therefore scored well.’|
Exam focus point
|3.4 Enterprise Management Incentives (EMI)||6/10, 6/14|
No income tax or NIC is chargeable on either the grant or exercise of options under the enterprise management incentive (EMI) scheme provided the exercise takes place within 10 years of the grant and the exercise price is at least equal to the market value of the shares at the date of the grant.
3.4.1 How the scheme operates
The EMI scheme is intended to help smaller, higher risk companies recruit and retain employees who have the skills to help them grow and succeed. They are also a way of rewarding employees for taking a risk by investing their time and skills to help small companies achieve their potential. Employees must spend a certain amount of time working for the company each week (see below) to be eligible to be given EMI options, but the company can choose to which of the eligible employees it grants such options. Therefore the EMI scheme is particularly useful if a company wishes to reward its key employees.
EMIs are similar to CSOPs, as an employee is granted options to buy shares. Specific features of the EMI scheme include the following:
- A qualifying company can grant each of its employees options over shares worth up to £250,000 at the time of grant, subject to a maximum of £3m in total.
- The company may set a target to be achieved before an option can be exercised. The target must clearly be defined at the time the option is granted.
- Options can be granted at a discount below the market value at the date of grant, although there are tax consequences of this (see below).
Some of these features make the EMI a more attractive scheme than a CSOP, but there are restrictions, in particular regarding which companies can operate EMI schemes.
Exam focus EMIs were tested in June 2010 Qu 4(a) Dokham. The examiner commented that ‘A significant number of point candidates confused the enterprise management incentive scheme with the enterprise investment scheme.’
3.4.2 Tax implications of grant and exercise of options
No income tax or national insurance is chargeable on either the grant or exercise of the options provided the exercise takes place within 10 years of the grant and the exercise price is at least equal to the market value of the shares at the date of the grant.
If the options were granted at a discount to the market value at the date of grant, there is an income tax charge (and possibly a national insurance contributions charge) when the options are exercised (not when they are granted) on the lower of:
- The discount (ie the difference between the market value of the shares at the date of grant and the price paid for the shares (the ‘exercise’ price)), and
- The difference between the market value of the shares at the date of exercise and the exercise price.
3.4.3 Tax implications of sale of shares
No income tax or national insurance is chargeable on the disposal of shares acquired under an EMI scheme.
When the shares are sold, any gain is subject to CGT. The cost in the gain calculation is the amount paid for the shares plus any discount taxed as earnings as described above.
Melody is employed by J plc. In October 2015, J plc granted Melody options to purchase 25,000 shares at a price of £4.50 per share under the EMI scheme. The market value of the shares at the date of the grant was £4.75 per share. Melody intends to exercise her options in June 2017 (when the market value is estimated to be £5.50 per share) and sell the shares in December 2018, when she thinks they will be worth £6.50 per share.
What are the tax implications for Melody when she exercises her EMI share options and when she sell the shares? Assume that the tax rules in 2015/16 continue to apply for the foreseeable future.
In 2017/18, when Melody exercises the options and purchases shares in J plc, she will be liable to income tax and national insurance on the amount by which the value of the shares at the time the options were granted exceeded the price she pays for the shares, ie £6,250 (25,000 × (£4.75 – £4.50)). This is the amount taxed as it is lower than the difference between the market value at the time of exercise and the exercise price (ie 25,000 × (£5.50 – £4.50) = £25,000).
In 2018/19, when she sells the shares, she will have the following gain on sale:
|Sale proceeds 25,000 £6.50||162,500|
|Less price paid for shares 25,000 £4.50||112,500|
|discount taxed as earnings on exercise||6,250|
Where an individual acquires shares on the exercise of an EMI option and disposes of those shares realising a chargeable gain, the gain is eligible for entrepreneurs’ relief where the option was granted at least one year before the date of disposal (ie the period of ownership of the option counts towards the one year ownership condition for entrepreneurs’ relief to apply). The individual must have been an employee or officer for at least one year ending with the disposal date, but does not need to own at least 5% of the company’s shares, which is one of the usual conditions for entrepreneurs’ relief to apply. We look at entrepreneurs’ relief in detail later in this Text.
3.4.4 Conditions for EMI schemes: qualifying company
The company, which can be listed on a stock exchange, must meet certain conditions when the options are granted. In particular, the company’s gross assets must not exceed £30m. The company must not be under the control of any other company.
The company must carry on one of a number of qualifying trades. It must have a permanent establishment in the UK.
The company must have less than 250 full-time equivalent employees at the time the options are granted.
3.4.5 Conditions for EMI schemes: eligible employees
Employees must be employed by the company or group for at least 25 hours a week, or, if less, for at least 75% of their working time (including self-employment). Employees who own 30% or more of the ordinary shares in the company (disregarding unexercised options shares) are excluded.
3.4.6 Conditions for EMI schemes: qualifying shares
The share must be fully paid up irredeemable ordinary shares. The rules permit restrictions on sale, forfeiture conditions and performance conditions.
3.4.7 Conditions for EMI schemes: limit
At any one time, an employee may hold EMI options over shares with a value of up to £250,000 at the date of grant. Restrictions and conditions attaching to the shares may not be taken into account when valuing shares.
Where options are granted above the £250,000 limit, relief is given on options up to the limit. Once the employee has reached the limit, no more EMI options may be granted for 3 years ie the employee may not immediately top up with new options following the exercise of old options.
Any options granted under a CSOP reduce the £250,000 limit, but SAYE share options can be ignored.
3.4.8 Conditions for EMI schemes: disqualifying events
There are a number of disqualifying events including an employee ceasing to spend at least 75% of their working time with the company. EMI relief is available up to the date of the event.
3.4.9 Costs of EMI schemes
The costs of setting up a scheme and on-going administration are deductible in computing profits.
3.4.10 Notification of grant of options in EMI schemes
HMRC must be notified online of the grant of options within 92 days. HMRC then has 12 months to check whether the grants satisfy the EMI rules.
3.5 Share Incentive Plans (SIPs) 12/14
Employees may be given £3,600 of ‘free’ shares a year under a share incentive plan (SIP). In addition, they can purchase up to £1,800 worth of ‘partnership’ shares a year and employers can provide up to £3,600 worth of matching shares. Once the shares have been held for five years there is no income tax or NIC when shares are taken out of the plan.
3.5.1 How the scheme operates
SIPs differ from the other tax advantaged schemes, in that options are not granted to employees, but, instead, they are given shares which are held in the plan. All full and part-time employee of the company (subject to a minimum period of employment) must be eligible to participate in the plan.
There are four ways that shares can be acquired by members of a SIP:
- Free shares: an employer can give up to £3,600 of free shares a year to an employee. An employer offering free shares must offer a minimum amount to each employee on ‘similar terms’. Between the minimum and the maximum of £3,600, the employer can offer shares in different amounts and on different bases to different employees. This means that the employer can reward either individual or team performance. The employer can set performance targets subject to the overriding requirement that a plan must not contain any features that concentrate rewards on directors and more highly paid employees.
- Partnership shares: an employee can also purchase partnership shares at any time in the year. These shares are funded through deduction from the employee’s pre-tax salary up to the lower of £1,800 and 10% of salary in any tax year.
- Matching shares: an employer can also award matching shares free to an employee who purchases partnership shares at a maximum ratio of 2:1.
- Dividend shares: dividends on shares in the plan are tax-free provided the dividends are used by the employee to acquire additional shares in the company, which are then held in the plan for three years. The company may specify a percentage (which may be 100%) of dividends that may be used to acquire dividend shares and modify that percentage from time to time.
A plan may provide for free and matching shares to be forfeited if the employee leaves within three years, unless the employee leaves for specified reasons such as retirement or redundancy.
The plan must be operated through a UK resident trust. The trustees acquire the shares from the company or – if the plan incorporates partnership shares – from the employees. The existence of arrangements to enable employees to sell shares held in a new plan trust will not of itself make those shares readily convertible into cash and require employers, for example, to operate national insurance.
Stamp duty is not payable when an employee purchases shares from a SIP trust. The trust must pay stamp duty when it acquires the shares. No taxable benefit arises on an employee as a result of a SIP trust or an employer paying either stamp duty or the incidental costs of operating the plan.
3.5.2 Tax implications on giving shares and on withdrawal of shares from plan
There is no income tax or national insurance when shares are given to employees (and put in the plan) as described above.
Free and matching shares must normally be held in a plan for at least three years. If shares are withdrawn within three years (because the employee leaves) there is a charge to income tax (as specific employment income) and NIC on the market value of the shares at the time of withdrawal. If shares are taken out of the plan after three years but before five years, there is charge to income tax and NIC based on the lower of the initial value of the shares and their value at the date of withdrawal, so any increase in value is free of income tax and NIC. If one of the specified reasons applies, eg redundancy or retirement, there is no tax or NIC charge. Once the shares have been held for five years, there is no income tax or national insurance when shares are taken out of the plan.
Partnership shares can be taken out at any time. If the shares are held for less than three years, there is a charge to income tax and NIC on the market value at the time the shares are removed. If the shares are removed after three years but before five years, the charge to income tax and NIC is based on the lower of salary used to buy the shares and the market value at the date of removal. Once the shares have been held for five years, there is no income tax or national insurance when shares are taken out of the plan.
3.5.3 Tax implications of sale of shares
There is no charge to CGT on shares taken out of a plan and sold immediately. A charge to CGT will arise on sale to the extent that the shares increase in value after they are withdrawn from the plan.
3.5.4 Conditions for SIPs
Shares in the plan must be fully paid irredeemable ordinary shares in a company either:
(a) Listed on a recognised stock exchange (or in its subsidiary), or (b) Not controlled by another company.
A plan established by a company that controls other companies, may be extended to any or all of these other companies. Such a plan is called a group plan.
A plan need not include all the components – it is possible to have a plan with only free shares.
Companies must offer all full and part-time employees the opportunity to participate in the plan. A minimum qualifying period of employment of up to 18 months may be specified. Any minimum period specified can be satisfied by working for any company within a group.
3.5.5 Costs of SIPs
A deduction in computing profits for the company is given for:
- The costs of setting up and administering the plan.
- The gross salary allocated by employees to buy partnership shares.
- The costs of providing shares to the extent that the costs exceed the employees contributions.
- The market value of free and matching shares when they are acquired by the trustees.
- Interest paid by the trustees on borrowing to acquire shares where the company meets the trustees’ costs.
3.6 Tax advantaged share schemes summary
|Scheme name||Gift/purchase/option scheme||Tax advantages||Employees|
|Tax free savings bonus
No income tax/NIC on exercise
CGT on sale of shares
|No income tax/NIC on exercise
CGT on sale of shares
|No income/NIC tax on exercise
(unless granted at a discount)
CGT on sale of shares
|SIP||Gift from employer and/or purchase by employee|| ||Favourable income tax charge if shares held 3yrs
No income tax/NIC if held 5 yrs
CGT on sale of shares
4 Lump sum payments
Payments made on the termination of employment may be fully taxable, partially exempt or exempt. The first £30,000 of a genuinely ex gratia termination payment is normally exempt.
4.1 Payments on the termination of employment 6/12, 12/12, 6/14
Termination payments may be entirely exempt, partly exempt or entirely chargeable.
4.1.1 Exempt termination payments
The following payments on the termination of employment are exempt.
- Payments on account of injury, disability or accidental death
- Lump sum payments from registered pension schemes
- Legal costs recovered by the employee from the employer following legal action to recover compensation for loss of employment, where the costs are ordered by the court or (for out-ofcourt settlements) are paid directly to the employee’s solicitor as part of the settlement.
4.1.2 Fully taxable termination payments
Payments to which the employee is contractually entitled are, in general, taxable in full as general earnings. Payments for work done (terminal bonuses), for doing extra work during a period of notice, payments in lieu of notice where stated in the original contract, or for extending a period of notice are therefore taxable in full. A payment by one employer to induce an employee to take up employment with another employer is also taxable in full.
An employee may, either on leaving an employment or at some other time, accept a limitation on their future conduct or activities in return for a payment. This is known as a restrictive covenant. Such payments are taxable as general earnings. However, a payment accepted in full and final settlement of any claims the employee may have against the employer is not automatically taxable under this rule.
4.1.3 Partly taxable termination payments
Other payments on termination (such as compensation for loss of office and statutory redundancy pay), which are not taxable under the general earnings rules because they are not in return for services, are nevertheless brought in as amounts which count as employment income. These are often called ex gratia payments. Such payments are partly exempt: the first £30,000 is exempt; any excess is taxable as specific employment income.
4.1.4 Benefits provided on termination
Payments and other benefits provided in connection with termination of employment (or a change in terms of employment) are taxable in the year in which they are received. ‘Received’ in this case means when it is paid or the recipient becomes entitled to it (for cash payments) or when it is used or enjoyed (non-cash benefits).
All payments to an employee on termination, both cash and non-cash, should be considered. Non-cash benefits are taxed by reference to their cash equivalent (using the normal benefits rules). Thus if a company car continues to be made available to an ex-employee say for a further year after redundancy they will be taxed on the same benefit value as if they had remained in employment. The normal exemptions apply, so that the continued use of one mobile telephone and work related training would be exempt.
4.1.5 Special situations
HMRC regard payments notionally made as compensation for loss of office but which are made on retirement or death (other than accidental death) as lump sum payments under non registered pension schemes, and therefore taxable in full. Also, payments in circumstances which amount to unfair dismissal are treated as eligible for the £30,000 exemption.
4.1.6 Practical issues
If the termination package is a partially exempt one and exceeds £30,000 then the £30,000 exempt limit is allocated to earlier benefits and payments. In any particular year the exemption is allocated to cash payments before non-cash benefits.
Employers have an obligation to report termination settlements which include benefits to HMRC by 6 July following the tax year end. No report is required if the package consists wholly of cash. Employers must also notify HMRC by this date of settlements which (over their lifetime) may exceed £30,000.
4.2 Example: redundancy package
Jonah is made redundant on 31 December 2015. He receives (not under a contractual obligation) the following redundancy package:
- Total cash of £40,000 payable £20,000 in January 2016 and £20,000 in January 2017
- Use of company car for period to 5 April 2017 (benefit value per annum £5,000)
|In 2015/16 Jonah receives as redundancy:|
|Car (£5,000 3/12)||1,250|
wholly exempt (allocate £21,250 of £30,000 exemption to cash first then benefit).
In 2016/17 Jonah receives:
Exemption (remaining) ) Taxable
£11,250 (£20,000 less £8,750) of the cash payment is taxable.
|June 2012 question 4(a) Tetra tested termination payments. The examiner commented that this part of the question ‘was done well by the majority of candidates with many scoring full marks.’|
Exam focus point
4.3 Other lump sum payments
Where lump sums are received otherwise than in connection with the termination of employment they will be taxable if they derive from the employment. Examples are:
- A golden hello, which is a one-off payment made to encourage someone to join a new employer. As it is effectively a reward for future services it is subject to both tax and NIC.
- A payment for a change in the terms of employment is also taxable.
|||Where shares or share options are provided to an employee, income tax and/or national insurance contributions may be payable.|
|||An employee may be given shares in exchange for giving up certain employment rights and receive tax advantages in relation to those shares.|
|||There are a range of tax advantaged share schemes under which an employer may be able to give employees a stake in the business.|
|||A Save As You Earn (SAYE) share option scheme allows employees to save regular monthly amounts for a fixed period and use the funds to take up options to buy shares free of income tax and NIC. Alternatively they can simply take the cash saved.|
|||There is no income tax or NIC on the grant of a Company Share Option Plan (CSOP) option. There is also no income tax or NIC on an exercise taking place between three and ten years after the grant. Only CGT will apply to the profit on disposal of the shares.|
|||No income tax or NIC is chargeable on either the grant or exercise of options under the enterprise management incentive (EMI) scheme provided the exercise takes place within 10 years of the grant and the exercise price is at least equal to the market value of the shares at the date of the grant.|
|||Employees may be given £3,600 of free shares a year under a share incentive plan (SIP). In addition, they can purchase up to £1,800 worth of partnership shares a year and employers can provide up to £3,600 worth of matching shares. Once the shares have been held for five years there is no income tax or NIC when shares are taken out of the plan.|
|||Payments made on the termination of employment may be fully taxable, partially exempt or exempt. The first £30,000 of a genuinely ex gratia termination payment is normally exempt.|
- Julia is employed by Z plc, a company whose shares are listed on the London Stock Exchange. In July 2015 she was sold 3,000 Z plc shares by the company for £1 each when they had a market value of £4. Julia is not an employee shareholder. What is are the income tax and national insurance consequences of this sale?
- What is the amount of the payment that an employee shareholder is deemed to have paid for employee shareholder shares?
- Which tax advantaged share option scheme allows employees to take a cash amount instead of exercising their options?
- What is the maximum amount of enterprise management incentive scheme options that an employee can hold?
- How may ‘free shares’ can an employee receive under a share incentive plan?
- How many matching shares can be given in respect of each partnership share purchased?
- On what value is income tax charged if shares held within a share incentive plan are disposed of within three years?
- Which termination payments are partly exempt?
- Thomas was made redundant on 4 January 2016. His severance package was:
Statutory redundancy pay £12,000
Golden Goodbye £40,000
The ‘Golden Goodbye’ was a payment made by the company to ‘soften the blow’ of redundancy to
Thomas. It was not paid as part of his contract of employment. How much of the above is taxable?
Answers to quick quiz
- Julia is treated as receiving specific employment income of £(4 – 1) 3,000 = £9,000 in 2015/16. She is also treated as receiving earnings of this amount for national insurance purposes as they are readily convertible assets.
- SAYE share option scheme.
- At any one time an employee may hold options over shares worth up to £250,000 at the date of grant.
- Up to £3,600 worth of free shares.
- Up to two.
- Income tax is charged on the market value of the shares on the date of withdrawal.
- The first £30,000 of genuinely ex gratia termination payments ie not in return for services.
|Statutory redundancy and Golden Goodbye £(12,000 + 40,000)||£52,000|