BIM44365 - Specific deductions - employee share schemes: Providing shares under FA03/SCH23 - forfeitable shares from 1/9/2003

Special rules in Part 4 of FA03/SCH23 apply if the qualifying shares acquired by employees are forfeitable shares. These are shares which are subject to restrictions which may result in the employee having to forfeit the shares for less than their market value for reasons other than cessation of employment due to misconduct.

The rules in Part 4 were amended from 1 September 2003 to reflect changes to employment income tax charges in respect of forfeitable shares introduced from that date by FA03/SCH22.

The new rules in Part 4 apply from 1 September 2003 to forfeitable shares acquired by employees on or after 16 April 2003.

There is guidance at BIM44375 on the position for forfeitable shares acquired:

• before 16 April 2003, or
• on or after 16 April 2003 if, unusually, the risk of the employee forfeiting the shares ceases before 1 September 2003.

From 1 September 2003

From 1 September 2003 deductions under FA03/SCH23 relating to forfeitable shares acquired on or after 16 April 2003 are aligned with the timing and amounts on which the employee is chargeable to tax as employment income (or, for shares acquired through a tax-advantaged EMI option, would be chargeable but for an exemption from tax).

There are 3 categories of ‘relief-triggering’ events under FA03/SCH23 Part 4 (as amended by FA03/SCH22). The events, and the deductions given for the periods in which they occur, are:

Employment income tax charges on acquisition of shares

From 1 September 2003 the general rule is that there is no income tax (or NICs) charge in respect of the acquisition of the shares. Exceptions are if:

• there is a risk of forfeiture which lasts for 5 years or more; or
• the share acquisitions arise from existing rights (for example by exercising a share option); or
• an election is made under ITEPA03/S425 for the employee to pay tax on the value of the shares on acquisition, taking into account the effect of the restrictions; or
• an election is made under ITEPA03/S431 for the employee to pay tax on the value of the shares on acquisition, ignoring the restrictions.

Employment income tax charges on post-acquisition events

From 1 September 2003, for shares acquired on or after 16 April 2003, each restriction placed on a share has a proportionate effect on its market value. Each time a restriction is lifted or varied there is an income tax (and NICs) charge based on the market value of the discount relating to that restriction. The discount relating to a restriction represents the proportion of the shares’ value that was not taxable on acquisition.

The amount chargeable to income tax is calculated using a formula. An Excel-based calculator to help with the relevant income tax computations is available on request (by e-mail) from the Share Schemes Team, Capital & Savings, Somerset House.

In the simplest case (where there is only one restriction) the amount chargeable to income tax is equal to the restriction’s effect on the market value of the shares at the time it is lifted. The result is that the employee is taxed on the whole share in two stages:

• an amount at acquisition relating to the unrestricted portion of the share, and
• the balance when the restriction is lifted.

By focussing on proportions of the shares’ market value at each event, the capital growth on previously taxed proportions is not included in the computation of the amount of the gain chargeable to income tax.

Examples

The examples at BIM44370 illustrate the employment income tax charges which arise from 1 September 2003, and related deductions under FA03/SCH23, in the following situations:

• Example 1 - forfeitable shares acquired on or after 16 April 2003 (other than through a share option); forfeiture period less than 5 years.
• Example 2 - forfeitable shares acquired on or after 16 April 2003; forfeiture period 5 years or more.