ERSM90500 - Post Acquisition Benefits from Securities

Ratchets and other geared arrangements

Background

On 16th April 2003 Schedule 22 to Finance Bill 2003 was published detailing the replacement legislation affecting the taxation of employment-related securities and options.

Following discussions with the BVCA a joint memorandum of understanding (MOU - see ERSM30520) was published on 25th July 2003 on the Income Tax treatment of managers’ equity investments in venture capital and private equity backed companies. This MOU was largely concerned with the effect of new Chapter 2 Part 7 ITEPA2003, but section 6, after addressing the tax treatment of ratchet arrangements for Chapter 2 purposes, went on to explain that, provided

  1. there were no personal performance conditions attached to the ratchet;
     
  2. the ratchet arrangements were in existence at the time the Venture Capitalist acquired his shares; and
     
  3. the managers paid a price for shares reflecting their maximum economic entitlement,

then there would be no further liability, arising from the ratchet of itself, under Chapters 1 to 5 Part 7 ITEPA.

Subsequently FAQ 4(a) was published setting out the Revenue’s view as to how a Chapter 4 benefit charge on a ratchet (outwith the MOU) might be calculated and suggested using a formula based on a charge equal to the excess increase in value of the shares disproportionate to the amount of capital invested by the manager compared with other holders of equity. HMRC also came to the view that a Chapter 4 benefit could arise where a company was thinly capitalised, where this gave rise to disproportionate reward in the hands of employee shareholders.

Disputed view on applicability of Chapter 4

Advice as to the applicability of such a Chapter 4 benefit charge was sought from legal counsel, who advised that a charge under Chapter 4 was not sustainable where the benefit to the holder of the shares from these ratchets reflected rights already present in that class of share at time of acquisition by the employee, or in terms of the thin capitalisation argument.

Effect on MOU on managers’ equity

The MOU guidance as it relates to Chapter 2 (restricted securities) remains in place, but see below under “revised guidance”.

Effect on FAQ4(a) and (c)

The guidance provided at FAQ4(a) and FAQ4(c) is withdrawn.

Revised guidance

Where shares are acquired under arrangements consistent with those described in Sections 1 to 5 of the Managers’ MOU then, where there is a ratchet operating at an”exit”, no Chapter 4 benefit charge will arise on the disposal of such shares or, if earlier, on operation of the ratchet. Where, in addition, the ratchet meets all the conditions in Section 6(2)(a) and (b) of the MOU, any gains realised on exit will be subject to CGT only, and not to Income Tax and NICs. Where the arrangements are not consistent with Sections 1 to 5 of the MOU, or where the Section 6(2)(a) and (b) conditions are not met, charges remain possible under:

  • Chapter 3B (securities with artificially enhanced market value - ERSM60000
  • Chapter 3D (securities disposed of for more than market value) - ERSM80000
  • Chapter 4 (post-acquisition benefits from securities) - ERSM90000
  • Section 62 (general earnings) - ERSM20500

Such cases will need to be considered on their own facts. COP10 applications may be submitted to Employee Shares & Securities Unit (ESSU) - see ERSM10040

Settled cases

Pre-16 April 03 ratchets are grandfathered per FAQ4(b), so we have already accepted no liability arises on operation of such ratchets.

For post 16 April 03 ratchets, a submitted return may be amended within the enquiry window. The normal time limit for amending a return for the year ending on 5 April is the first anniversary of the 31 January following that year. For example, the time limit for amending a return for 2004/05 is 31 January 2007 because 2004/05 ends on 5 April 2005 and so the 31 January following the year 2004/05 is 31 January 2006 and its first anniversary is 31 January 2007. In cases of doubt or difficulty local offices should submit the case to ESSU (ERSM10040).

In the rare event that shares were acquired on or after 16/4/03 and a ratchet operated on or before 5/4/04, an error or mistake claim under S33 TMA 1970 should be made. Please initially send all such claims to ESSU (address above).

Where it is established that as a result of reliance on previously published guidance, an overpayment of National Insurance contributions has occurred, any application, together with the necessary supporting documentary evidence, for the return of those contributions should be sent to:

George Robson
HMRC, PAYE/NICs (Technical) Group
Room BP7201
Benton Park View
Longbenton
Newcastle upon Tyne
NE98 1ZZ