IR 2005: Share Incentive Plans |
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Guidance for employers and advisors
Contents
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This detailed guidance has been drawn up to help companies that wish to set up and run a Share Incentive Plan themselves. The information contained in this booklet is for guidance only. For a Share Incentive Plan to gain and retain Inland Revenue approval it must at all times comply with the provisions of Schedule 8 Finance Act 2000, as amended by Schedule 13 Finance Act 2001. Unless otherwise stated, the statutory references in this booklet are to these Acts and the abbreviations Sch 8 and Sch 13 have been used throughout. The Acts can be found on the Internet Companies should obtain professional advice or request the help of Inland Revenue Share Schemes if they have any questions. A Share Incentive Plan is a tax-advantaged plan to encourage employees to hold shares in the company or group for which they work. What does the plan offer to smaller companies?The Share Incentive Plan legislation includes features intended to make the Plan attractive to smaller companies that may previously not have had an employee share plan. The legislation includes provision for some special features to make a Share Incentive Plan attractive to unlisted companies, which may not have a ready market for their shares. This guide is designed to address issues in the order companies are likely to come across them in putting together and running a Share Incentive Plan. It is set out in three sections. Section One is about implementing a Share Incentive Plan and covers
Section Two is about how to operate a plan and covers
Section Three provides further sources of information and help on tax issues Summary of Share Incentive Plan legislation What is an Inland Revenue-approved plan? A Share Incentive Plan is designed to be operated as an Inland Revenue-approved plan, which offers tax and National Insurance advantages. A company will have to send us details of its Share Incentive Plan for formal approval before it can start operating the plan. We will check that a plan complies with the Share Incentive Plan legislation before granting approved status (Para 4(1) Sch 8). A Share Incentive Plan can operate without approval, but it will not benefit from the tax advantages that approved status can provide. What are plan shares?The Share Incentive Plan legislation provides for three main types of plan shares to be used. They are
Various combinations of types of plan share can be used, for example,
free shares only, or partnership with or without matching shares,
or another combination to suit the business needs of the company Companies can also allow an employee to use up to £1,500 of
dividends from his or her plan shares each year to buy further shares
in the company through the plan. The term plan share refers to these four types of shares that are available under a Share Incentive Plan. What optional features are there? As well as being able to choose between the four different kinds of plan shares described on page 4 to build a plan that suits its business needs, employers can also include other optional features, such as
These features are designed to make the Share Incentive Plan attractive and workable for as wide a range of businesses as possible. What are the tax advantages for participants of a Share Incentive Plan? Employees who receive free or discounted shares in the company they work for normally have to pay income tax and National Insurance contributions (NICs) on those shares, because they are part of remuneration. But, employees who take part in a Share Incentive Plan will have the opportunity to pay less or no tax, or NICs, on the shares they acquire under the plan. Whether an employee will have to pay any tax or NICs on a particular acquisition of shares will depend on a number of factors, including
The Share Incentive Plan legislation allows an employee to purchase partnership shares out of his or her salary before tax and NICs are deducted, which reduces the amount of salary on which he or she will have to pay tax and NICs. Employees whose total earnings are below the upper earnings limit (UEL) for NICs purposes will benefit from a reduction in the amount of NICs they have to pay. However, employees whose earnings exceed the upper earnings limit (UEL) after the deduction of partnership share money will not make this saving if they purchase partnership shares. There is no tax charge on certain dividends paid on plan shares used to buy further plan shares that remain in it for at least three years. As lower and basic rate taxpayers already pay no further tax on receipt of a dividend, it is only higher rate taxpayers, or those brought into higher rates because of the dividends, who will benefit from the tax free status. Are there any situations where social security benefits could be affected? Buying partnership shares under a plan may affect an employee's entitlement to certain social security benefits, statutory maternity pay and statutory sick pay. This is because an employee will not have paid NICs on the pay that he or she used to buy the partnership shares. This will only affect a very small number of people, and our leaflet IR177 'Share Incentive Plans and your entitlement to benefits' explains this in more detail. The information should be made available to all employees. Details of how to obtain the leaflet are on the inside front cover of this booklet. Are there benefits to an employer for providing a Share Incentive Plan?Provided the necessary conditions are met, an employer can claim relief against corporation tax (CT), and is not liable for employer's NICs on shares given to, or purchased by, employees through a Share Incentive Plan (Para 106 & 107 Sch 8). In addition, certain other expenses incurred by a company in relation to a Share Incentive Plan may be eligible for relief against CT (Para 111 & 112 Sch 8). Is a trust necessary?Companies will have to set up a trust to hold the Share Incentive Plan shares. This trust has to satisfy certain requirements set out in the legislation (Para 68 Sch 8). What about extra administration?The amount of work involved in administering a Share Incentive Plan will depend on how simple or complex that plan is. For example, awards of plan shares will need to be recorded and monitored, so that the correct tax treatment is given when employees take their shares out of the Share Incentive Plan. Companies can choose to outsource this administration work, or it could be done in-house. Additional Pay As You Earn (PAYE) tax and NICs obligations may arise for companies as a result of operating a Share Incentive Plan Section One Implementing a Share Incentive Plan There are three steps to implementing a Share Incentive Plan.
Step one - check that the requirements for Inland Revenue approval can be met The first step in implementing a Share Incentive Plan is to establish whether the company will be able to operate it according to the rules set out in Sch 8 FA 2000, as amended by Sch 13 FA 2001. They set out the requirements that need to be met and the way that a Share Incentive Plan should operate if it is to secure Inland Revenue approval. The main requirements cover
This booklet explains the requirements and the flowchart summarises them. What is the purpose of a Share Incentive Plan? The purpose of the plan is to provide share benefits to employees,
which give them a continuing stake in the company (Para 7(1) Sch 8).
The tax reliefs available for a Share Incentive Plan are conditional
on that being the purpose of the plan. This means that we will not approve a Share Incentive Plan, which contains in its trust deed or rules and share agreements, or in the way that it operates, anything which is not essential to the aim of encouraging employee share ownership, or is not reasonably incidental to that purpose. For example, a Share Incentive Plan that offers employees cash bonuses as an alternative to shares would not be approved. We will not approve a plan that uses a performance measure to calculate a bonus of £10,000, with employees having a choice of either taking £3,000 in shares and £7,000 in cash, or £10,000 in cash. This does not, of course, affect the ordinary operation of companies' discretionary cash bonus schemes. A company can let its employees know that if they do not wish to participate in an award of shares under the plan, the company may consider a discretionary cash payment. But, if the cash award becomes established as an alternative to shares, so that employees expect cash rather than shares, then the operation of the plan may, in fact, contain a feature which is neither essential nor reasonably incidental to the purpose of the plan - the provision of share benefits to employees. What is meant by the all - employee nature of the plan? The plan must be open to all employees who are
Although companies must offer participation to all of these employees, the employees themselves may of course decide not to take part. Part-time employees must be included in the offer and they must be treated in exactly the same way under the plan rules as full-timers. Awards of free shares can be tailored to the number of hours that employees work (see opposite). In addition, companies may offer participation to eligible employees who are not subject to tax under Case 1 Schedule E in respect of their employment with the company (Para 8(3) Sch 8). Can a company set whatever rules it wishes? No. A Share Incentive Plan must not contain any features that might discourage any eligible employees from participating, for example, a requirement for participants to
All employees who take part in a Share Incentive Plan must do so on the same terms (Para 9(1) Sch 8). This does not prevent a company varying the number of free shares awarded to employees in the ways permitted by the legislation. The rules allow free shares to be awarded by reference to an employee's remuneration, length of service, or hours worked (Para 9(3) Sch 8). The same terms requirement does not prevent a company imposing a performance condition on awards of free shares, as long as it complies with the Share Incentive Plan legislation (Para 9(5) Sch 8). If a company decides to vary awards of shares by reference to level of remuneration, length of service, or hours worked, these factors must be treated separately and the separate entitlements added together to arrive at the total entitlement. ExampleXYZ Limited decides to make an award based on level of pay and length of service. A salary band of £5,000 is acceptable and gives rise to one unit for every £5,000 of pay, with each unit worth a given number of shares. Length of service entitles employees to one unit for every year of service. Adam earns £30,000 and has seven years service. Ali earns £20,000 and has three years service. These units cannot be multiplied because the result would be disproportionate
What is to stop preferential treatment being given to directors? We would not approve a plan containing features which benefit mainly directors or higher paid employees (Para 10(1) Sch 8). For example, we would not approve a Share Incentive Plan that was designed to channel a disproportionate number of shares towards groups of directors or higher paid staff. However, this does not prevent a company from being able to vary awards of shares according to the employees' levels of remuneration (Para 9(3) Sch 8). Can further conditions be introduced?Yes, but a company must not include any requirements for participation in a Share Incentive Plan other than those permitted by the legislation that are referred to in this guide (Para 11 Sch 8). What about loan arrangements?A Share Incentive Plan must not be associated with loan arrangements under which employees borrow money from their employer in order to take part (Para 12 Sch 8). What eligibility criteria do employees have to meet? For employees to be eligible to participate, the plan rules must ensure that participants are employees of the company which has established the plan or, if it is a group plan, of a participating company. In the case of free shares, the employee must be eligible at the time of the award of free shares (Para 13(1) Sch 8). In the case of partnership and matching shares, the employee must be eligible either
Can a qualifying period of service be specified? Yes. Companies can specify a qualifying period of service before employees can take part in a Share Incentive Plan. The qualifying times may vary, for example
If a qualifying period is set, then the participant must be an employee of the company setting up the plan throughout that time. If it is a group plan, he or she must have been an employee of a qualifying company at all times during the qualifying period. A qualifying company is a company that
Different qualifying periods can be set for different awards of shares, but within each award all employees must be subject to the same qualifying period. What rule prevents employees with a material interest from participating? The rule that prevents those employees who already have a substantial shareholding in the company from benefiting further from the plan is known as the material interest rule. All plans must contain this rule. A material interest in a company means
The rule also prevents anyone taking part in a plan who has, or has within the previous 12 months had, a material interest in a
The rule is wide ranging. An individual is treated as having a material interest in a company (Para 15(2) Sch 8) if
Do share options count for material interest purposes? Options over shares are treated as a right to control them. The shares are taken into account for material interest purposes only if the company is under a contractual obligation to satisfy the option exercise with previously unissued shares (Para 18, Sch 8). Shares that would be issued on the exercise of options held by anyone other than the option holder whose material interest is being calculated (or an associate) are not added to the shares in which the interest must not exceed 25%. Shares that are held by the trustees of an Approved Profit Sharing Scheme or a Share Incentive Plan should be disregarded if they have not been appropriated or acquired on behalf of an individual (Para 19 Sch 8). Example ABC Limited has four shareholders. Ann holds 10,000 shares and has an option over a further 10,000 shares. The total issued share capital is 90,000 shares. A Share Incentive Plan is to be introduced and it is proposed that Ann participates, but not Beryl or Charlie. If Ann's option (if it was exercised) must be met by the issue of new shares, then her interest becomes 24,000 out of 100,000. This is less than 25% so is not a material interest and Ann can participate in the Share Incentive Plan. If, however, the exercise of Ann's option could be met by the transfer of existing shares, the interest would be 24,000 out of 90,000. This exceeds 25% so would be a material interest, and she cannot participate in the Share Incentive Plan. In order to participate, Ann would have to sell shares held over 25% and wait for a year. Shares that would be issued on the exercise of options by Beryl and Charlie do not need to be added to the shares in which the interest must not exceed 25%. For the purposes of the material interest tests, associate means
Settlement here means a trust. Settlor means the person who provided funds for the trust. Are trustees of an employee benefit trust counted as associates? The trustees of an employee benefit trust, as defined in Para 7 Schedule 8 Income and Corporation Taxes Act (ICTA) 1988, are not regarded as associates unless
has since 14 March 1989 been the beneficial owner of, or been directly or indirectly able to control, more than 25% of the ordinary share capital of the company (Para 21 Sch 8). If the individual is the object of a discretionary trust, and that trust holds shares in the company, those shares do not have to be counted in the material interest test if the individual disclaims that interest, or is excluded from it, provided
Can employees participate in other share schemes? An employee cannot receive an award of shares in the same tax year from
It is possible for an employee to receive an award of shares from an Approved Profit Sharing Scheme in the same tax year as he or she receives partnership or matching shares under a Share Incentive Plan. For these purposes, a connected company is one that
Where there has been a takeover, the test of whether the companies are connected should be applied at the time of the award. For example, an employee working for a company with a Share Incentive Plan that is taken over, may not receive shares under the acquiring company's plan if, earlier in the same tax year, he or she received shares in the plan of the company that has been acquired. View a flow diagram on eligibility and types of shares employees can acquire Which companies can set up a Share Incentive Plan? A company can set up a Share Incentive Plan solely for its own employees, or, if it controls other companies, extend the plan to employees of one or more of those companies. This is called a group plan (Para 2(1) Sch 8). Both listed and unlisted companies - UK and non-UK - can establish a Share Incentive Plan. What shares can be used in a plan? A Share Incentive Plan must only use shares that meet the requirements set out in this section; plan shares (Para 59 Sch 8). The plan shares must be ordinary shares of
Plan shares must be
Plan shares must also be
The exception is for redeemable shares in co-operatives that are registered as industrial and provident societies under the Provident Societies Act 1965 or the Industrial and Provident Societies Act (Northern Ireland) 1969 (Para 62 Sch 8). Can a company impose restrictions on its plan shares? The purpose of the Share Incentive Plan is to enable employees to become shareholders with a stake in the business in the same way as other shareholders. Generally, there is a requirement that the shares used do not have restrictions that do not also apply to other shareholders. However, rules set out in the Stock Exchange Model Code are not counted as restrictions for the purposes of the Share Incentive Plan (Para 63(4) Sch 8). Certain limited restrictions can be attached to the plan shares to enable more private companies to implement a Share Incentive Plan. These companies often have restrictions attached to shares that can be acquired by employees and directors. The restrictions that the Share Incentive Plan legislation permits are
What are pre-emption provisions? These are provisions attaching to shares that require shareholders to sell them if specified circumstances arise. Pre-emption provisions are allowed if they require employees and permitted transferees to offer their plan shares for sale if they leave employment. The provision must
In addition, the Articles must say that anyone selling shares of the same class must not be able to sell them on better terms than anyone else (Para 66 Sch 8). Step Two. Decide how the plan will operate in practice The Share Incentive Plan legislation contains many flexible elements, allowing each company to design a plan that meets its specific needs and objectives. This also enables a company to change the way its Share Incentive Plan operates to adapt to changing circumstances. Types of shares There are four types of shares (definitions on page 83)(Paras 1 & 23-58 Sch 8). They are
Different rules apply to each. The company can award up to £3,000 of free shares to each qualifying employee each tax year. The value of the shares is taken at the date the award is made. Shares subject to restrictions or a risk of forfeiture are valued as if there was no such restriction or risk (Para 24 Sch 8). Can a company link performance to an award of free shares? Yes. The company may link the award of free shares to the meeting of performance measures. The measures can be linked to either the number or the value of free shares awarded, and can apply to the performance of
The same terms rule does not apply to awards of shares linked to performance, provided the performance measures meet the requirements of the legislation. Performance measures must be based on business results or other objective tests (Para 27 Sch 8). What sorts of performance measures are allowed? The legislation sets out two ways in which a performance measure may work: Method 1 and Method 2. The company can choose between these two. Under Method 1, the company can structure its plan so that
The highest number of shares awarded to an individual by reference to performance must not be more than four times the highest number awarded to an individual without reference to performance (Para 29 Sch 8). The case study opposite illustrates this. Under Method 2, the company can award some or all the shares according to performance. In this case, all the employees within each separate performance unit must take part on the same terms. A performance unit is a group of one or more employees. Can there be different performance tests for each unit? Yes. The performance criteria can vary between business units. This enables companies to design performance conditions that meet their business needs, and that are directly relevant to groups of individuals (Para 30 Sch 8). If, under Method 2, different conditions are set for different performance units, those targets must be comparable. If they cannot reasonably be viewed as being comparable at the time that they are set in accordance with the plan, this is a disqualifying event and we may withdraw our approval of the plan (Para 118(2)(c) Sch 8). Remember that all performance conditions under Method 1 or Method 2 have to be
It is not possible to base awards of free shares on subjective measures, for example, annual performance appraisal ratings may contain subjective elements. Communicating the criteria to employees The company must notify all qualifying employees, in general terms, of the performance measures to be used as soon as reasonably practicable. The only exception is if the provision of the information would prejudice commercial confidentiality. In addition, all employees participating in an award must be told of the performance measures to be used in their individual case. Companies cannot withhold this information on the grounds of commercial sensitivity. Employees cannot receive a performance award from more than one performance unit at the same time. So, for each award of shares they can only be part of one performance unit (Para 27(4) Sch 8).
Does a Share Incentive Plan have to include a holding period? The company must set a holding period for each award of free shares, during which the plan shares must be held in the plan trust. In normal circumstances, the holding period must be three years, but the company can extend this to any period between three and five years from the date of award of the shares (Para 31(2) Sch 8). The period must be the same for all shares in the same award. Different holding periods can be set for different awards of free shares, but the holding period cannot be increased once the award is made (Para 31(3) Sch 8). Participants who have received free shares normally have to hold their shares in the plan for the whole of the holding period. But, the holding period automatically comes to an end if the employee leaves the company, because he or she can take the shares with them. However, the company's plan rules can provide for the shares to be forfeited if an employee leaves employment. Does there have to be a forfeiture period? Employees can be required to give up some or all of their free or matching shares if they leave employment or withdraw partnership shares from the plan during a period of time set by the company. This period can be up to three years from the date of award. Forfeiture cannot be linked to the performance of employees in any way, and the same forfeiture conditions must apply to all shares in the same award in the plan. The company cannot require any shares to be forfeited if an employee leaves involuntarily (Para 65(2) Sch 8). It may provide for forfeiture in specific cases, but the same provisions must apply to all participants in each award. It is possible for the proportion of shares that are subject to forfeiture to vary according to a pre-determined scale. Example 1 A company sets up a Share Incentive Plan providing free shares to its employees. It wishes to encourage employees to remain with the company, so imposes a restriction on the shares awarded. This restriction is that if employees leave
Example 2 A company sets up a Share Incentive Plan providing partnership and matching shares to its employees. It wishes to encourage employees to retain their partnership shares and therefore imposes a restriction on the shares awarded. Under this restriction, if employees withdraw partnership shares
A qualifying employee can use up to £1,500 out of pre-tax and NICs pay (opposite) per year to buy partnership shares (Para 36 Sch 8). What are partnership share agreements? If the company wishes to use partnership shares in its plan, it must arrange for the qualifying employees to enter into partnership agreements under which the company deducts money from those employees' salaries or wages, and arranges for shares to be purchased with the proceeds (Para 34 Sch 8). The agreement must specify the amount of the deductions from wages or salary, which might be done on a weekly or monthly basis, or over some other interval. There is a model partnership agreement available on our website What are accumulation periods? A plan with partnership shares can be operated with or without accumulation periods. These are periods over which deductions from salary are made. The partnership share money deducted must be used to buy partnership shares within 30 days of the end of the accumulation period. Companies can decide how long accumulation periods will be, subject to a maximum of 12 months (Para 41 Sch 8). If there is no accumulation period, the partnership share money must be used to buy shares within 30 days of the last time money was deducted from an employee in that month (or other pay period) (Para 40 Sch 8). Employees starting employment during an accumulation period cannot participate - they must be eligible at the time of the first deduction of partnership money relating to the award. The partnership share agreement may specify that an accumulation
period must come to an end if a specified event occurs (Para 41(3)
Sch 8). For example, it is possible for the partnership share agreement
to stipulate that it ends after 12 months A decision by the directors to terminate the period does not qualify as a specified event. Is there a maximum deduction? Yes. The deductions from salary must not exceed
Is there a minimum deduction? The company can set a minimum monthly amount to be deducted from pay. This must not be more than £10, and must apply to weekly and monthly paid staff equally (Para 37(1) Sch 8). For the purposes of calculating how much salary an employee can use to buy partnership shares, salary means earnings subject to PAYE, after deduction of expenses and benefits in kind (Para 48, as amended by Sch 13). How does a company set the contribution limits? The maximum contribution must be set before the start of the purchase period, whether or not there is an accumulation period. The plan can specify lower limits for deductions than those set by the legislation, and limits can differ for different awards (Para 36(3) Sch 8). But, a company must not unilaterally vary the limit during an accumulation period. How do monthly limits apply to weekly paid employees? Regardless of how often employees are paid, they must be able to contribute the same amount over a 12 month period, or, where there is an accumulation period, over each accumulation period. The £125 or 10% salary limit (whichever is the lower) (Para 36 Sch 8) is set in terms of a maximum per month. But if employees are paid on a different basis, for example, weekly, the amount deducted from each salary payment may be varied proportionately to the monthly limit. There is more than one way to achieve this, and any method can be used as long as
Example In Weavers Cloth Company a maximum contribution available to monthly paid employees is £1,500 over a 12 month period. Deductions from weekly paid employees can be made by either
What about over-deductions? If amounts are deducted from salary over and above the limits set for that award, the excess must be repaid to the employee as soon as practicable (Para 36(4) Sch 8). This depends on the circumstances of the company. It may be either the next pay day, or the one after that, if the payroll input deadline is missed. If this is as soon as practicable for a particular company, it will meet the requirements of the legislation. If a subsequent deduction is being made from salary the following month, the previous over-deduction can be taken into account by deducting less on this deduction. Repayments made to employees must be subject to PAYE and NICs deductions. How are partnership shares bought? The monthly limit of £125 or 10% of salary (whichever is the lower) refers to the level of deduction from salary, not to the value of shares purchased. When this money is used to buy shares, the purchase price may not be exactly divisible into the amount deducted. The market value of the shares will determine how many are awarded to each participant and, if there is an accumulation period, this is taken as the lower of
Example 1 The Mouse software company gives all its employees a chance to buy into the continuing success of the business by introducing a Share Incentive Plan. It provides the opportunity for employees to buy partnership shares and decides to use an accumulation period of 12 months. At the start of this accumulation period, the company's share price is £5. During the 12 months, there is a sharp upturn in technology shares, and by the end of the accumulation period, the company's share price has reached £10. As the share price has risen, the employees' accumulated salary deductions are used to buy shares for the market value at the beginning of the accumulation period: £5. This discount is tax-free. Example 2 The Disk software company introduces a Share Incentive Plan providing partnership shares and also decides to use an accumulation period of 12 months. At the start of the accumulation period, this company's share price is also £5. However, over the course of 12 months the business fails to grow as expected, and by the end of the accumulation period when it is time to acquire the shares, the company's share price has fallen to £3. As the share price has fallen, the employees' accumulated salary deductions are used to buy shares for the market value at the acquisition date: £3. What happens to any surplus money? The trustees must come to an agreement with the employee about what to do with any surplus money remaining. This might happen because of a change in the share price in the period between deduction of partnership share money from salary and the award of the shares. For example, if £100 was deducted when the share price was £20, but the share price increased to £22 on the date of award, only four shares can be awarded and there will be a surplus of £18. The surplus can be carried forward to the next month, or accumulation period, provided this has been agreed with the employee in his or her partnership share agreement (page 28) (Para 40(4) & 42(5) Sch 8). So, there can be instances where more than £125 (or equivalent amount if share purchases are made less often) is available for the next purchase of shares. If the money is not carried over it must be paid to the employee as soon as practicable, subject to PAYE and NICs (Para 42(5) Sch 8). What happens to money held by trustees? Partnership money deducted from employees' salary must be paid to the trustees of the plan trust as soon as practicable, and must be held by them until they use it to buy shares for each participant (Para 39(1) Sch 8). Any excess or surplus amounts, or amounts left over after the employee has left employment, must be repaid to him or her, subject to PAYE and NICs. In most cases the trustee will route the repayment through the employer's payroll. What happens to any interest on money held? The trustees must hold partnership money in a bank or building society account, which may or may not be interest-bearing (Para 39(3) Sch 8). If the account is interest-bearing, that interest will belong to the employee, and he or she will be subject to tax, which will be deducted at source by the bank or building society. Higher rate taxpayers account for all their tax on this interest through their Self Assessment tax return. It is not possible for interest to be added to partnership money in order to buy additional shares. Can interest be used to meet plan administration costs? Yes. A company and employees can agree that any interest earned on partnership money is used to meet the administration costs of the plan. But, the interest will remain part of the taxable income of each employee, even though they do not receive it. This means that the employees will be taxed on amounts of interest that they never receive. Employers are not able to ask employees to help them meet the administrative costs of the plan in any other way. Corporation tax (CT) deductions help with these costs. How does an employee stop deductions? The plan must allow employees to give notice, at any time, in writing to the company to stop making deductions from their pay (Para 44 Sch 8). How does an employee re-start deductions? Plans with an accumulation period, must allow participants to re-start the deductions, though missed deductions cannot be made up. A plan can prevent a participant from re-starting more than once during a particular accumulation period. For plans with no accumulation period, companies cannot limit the number of re-starts of deductions (Para 44 Sch 8). If an employee sends in a notice
How does an employee withdraw from a plan? Employees must be able to withdraw from their partnership agreement at any time, provided they give notice in writing to the company. Unless the employee specifies a later date in his or her notice, the withdrawal takes effect 30 days after the notice has been received (Para 45(3) Sch 8). Any unused partnership money must then be repaid to the employee as soon as practicable, subject to PAYE and NICs. We would not approve a plan if it required employees to meet the administrative costs of withdrawing shares. When does partnership money get repaid? Partnership money might not be used up in buying shares for the participant if
If an employee leaves, the money must be repaid subject to PAYE
and NICs. In other situations, the employee can agree that it
is carried forward to buy shares in the next award. If such an agreement
is not met, the money must be All partnership money must be repaid to the employees as soon as practicable (Para 46 Sch 8) if the surplus arises because
Matching shares are free shares awarded by the company to match the partnership shares bought by the employee out of his or her salary (page 28). They may be awarded using any ratio, subject to a maximum of two matching shares for each partnership share (Para 51(2) Sch 8). A company can provide for a match up to a fixed level of partnership shares bought, with the balance of partnership shares not attracting a match. Example Earle Limited structures its matching share award policy as follows. The first 5 partnership shares bought by employees are matched using a ratio of 2:1. So, an employee buying 5 partnership shares receives 10 matching shares. The next 5 partnership shares are bought using the ratio of 1:1. So, an employee buying 10 partnership shares receives 15 matching shares (10 + 5). The next 10 partnership shares are bought using a ratio of 1:2. So an employee buying 15 partnership shares receives 20 matching shares (10 + 5 + 5). If more than 20 partnership shares are acquired, no matching award is made. What are the main rules about matching shares? The matching shares must be
Is there a holding period? Yes. As with free shares, the plan must specify a holding period for matching shares. The same rules that apply to free shares also apply to matching shares: the holding period must be a minimum of three years and a maximum of five years (Para 52 Sch 8). Can there be a forfeiture period? Yes. As with free shares, the plan can provide for forfeiture of matching shares (Para 50(2) Sch 8), and the company can set a forfeiture period of up to three years. Forfeiture periods can be changed, introduced or removed between awards, but not for awards already made. If changes are made, all participants must be informed before matching share awards take place. In addition, the matching shares may be forfeited if the corresponding partnership shares are withdrawn from the plan during a forfeiture period. The plan can, if the company wishes, provide for dividends paid on plan shares to be reinvested in further shares. These are called dividend shares. Is there a limit to the reinvestment? The limit is £1,500 per year for each participant (Para 54(1) Sch 8). It applies to the total cash dividends used by the trustees to buy dividend shares, whether under the present Share Incentive Plan or any of the company's other Share Incentive Plans - or plans of associated companies - to which the employee may belong (Para 54(2) Sch 8). Any cash dividends exceeding the £1,500 limit, or which the employee has asked not to be reinvested, must be paid to him or her as soon as practicable (Para 53(3) Sch 8). How are dividends to trustees paid? When a company pays a dividend to the trustees, it must issue a dividend voucher in the usual way regardless of whether or not all or some of the dividend is reinvested. How does a company include dividend shares in a plan? The company can arrange for the plan to
The company may end the dividend reinvestment arrangement at any time. If an amount of the dividend (up to the limit of £1,500 per tax year) is reinvested in shares under a plan, the trustees must not issue a voucher for it. There is no tax credit in respect of that amount. What happens to dividends that are not reinvested? All dividends or parts of dividends that are not reinvested must be paid to the employees as soon as practicable. The trustees must issue a voucher for dividends paid in a plan to each of those employees, which must show the amount of the dividend passed on and the associated tax credit in the normal way. The requirement to pay the participant dividends that are not reinvested under the plan will be satisfied where the money is reinvested in further shares outside the plan in accordance with his or her instructions. Is there a holding period for dividend shares? There is a holding period for the dividend shares, but unlike free and matching shares the holding period must be three years (Para 57 Sch 8). What happens to dividend shares that cease to be subject to the plan? If the dividend shares cease to be subject to the plan within three years of being acquired, for example, because the employee leaves, the trustees must issue a voucher for
The amount chargeable to tax will normally be the amount of dividend used to buy those shares plus the tax credit. There are special circumstances where exit from the plan before three years does not bring about a tax charge (see page 63 for more details). The employee or former employee will need to declare the information provided on the voucher in his or her tax return. Lower or basic rate taxpayers will have no more tax to pay, unless the amount chargeable to tax takes them into the higher rate band. What happens to uninvested amounts? There may be amounts of cash dividends that are not reinvested straight away because the cash is insufficient to pay for a whole number of shares, or because amounts are left over after the acquisition. The trustees can carry the amounts forward to the next reinvestment. However, each sum must be clearly identifiable in the trust records, because this money must be paid to the employee if
If any of these events happens, the trustees must issue a voucher showing the amount paid, the date on which it was paid, and the amount of the tax credit applicable to that amount on that date. What rights must dividend shares carry? The dividend shares must be of the same class and carry the same rights as the shares on which the dividends were paid. Dividend shares must not be forfeitable (Para 55 Sch 8). How are dividend shares bought? In acquiring dividend shares, the plan trustees must treat participants fairly and equally. They must also use the cash dividends to buy extra shares within 30 days of receipt of those dividends, if the amount of money is sufficient. The number of shares to be acquired for each participant must be determined on the basis of the market value of those shares on the date they are acquired on behalf of employees: the acquisition date (Para 56 Sch 8). The market value of the dividend shares on the acquisition date may not necessarily be the price paid for those shares by the trustees because shares may come from a variety of sources, including
Designing your plan There are a number of areas where the legislation enables a company to decide how its specific Share Incentive Plan will operate. This means that a tailor-made plan can be put together by each company, taking into account its corporate strategy and needs, its resources and also the interests of its employees. A company has scope to make its own design decisions. The purpose of this section is to help highlight what design decisions a company can make, and some of the considerations to take into account when making those decisions. What are the different types of share award? There are three main types of share award. It is not necessary for all three types of share to be used by a company operating a Share Incentive Plan. A company can offer
A company cannot offer matching shares under a Share Incentive Plan unless it also offers partnership shares. In addition, dividend shares can be used in a plan. So in total, a plan can use four different types of share award. Things to remember when deciding what types of share award to use in a Share Incentive Plan.
Our model rules cater for all these types of share award and are shown on our website What about an accumulation period? Please see details on the operation of accumulation periods. If a company uses partnership shares in its Share Incentive Plan, it does not have to operate accumulation periods. Things to consider when deciding whether to include accumulation periods in a Share Incentive Plan.
Another design aspect is that the company may wish to consider whether to pay interest on cash held during the accumulation period (although there is no requirement to do this). How about reinvesting dividends? A company may, if it wishes, include dividend shares in its Share Incentive Plan, but there is no obligation to do so. If they are included, the legislation allows companies to include provisions in their plan rules for dividend reinvestment to be either compulsory, or the choice of each employee (Para 53(1) Sch 8). See reinvestment of dividends. Things to consider when deciding whether to include dividend shares in a Share Incentive Plan.
What about forfeiture for free and matching shares? A company can include provisions in a Share Incentive Plan that free and matching shares will be forfeited if the employee ceases to be employed, or takes the shares out of the plan, within the period of forfeiture. In addition, matching shares may be subject to forfeiture if the corresponding partnership shares are withdrawn from the plan. The forfeiture period may be up to three years from the date of award of those shares. See forfeiture. Again, this feature does not have to be included and the company can decide whether to include such provisions in the plan rules of its Share Incentive Plan. Things to consider when deciding whether to include forfeiture provisions in the plan.
Remember that the same provision for forfeiture must apply in relation to all free or matching shares included in the same award under the plan. It is not possible to include forfeiture provisions in relation to employees who cease employment as involuntary leavers (due to injury, disability, redundancy, TUPE transfer, change in control of the company, retirement or death). However, a company can have different forfeiture provisions for different types of other leavers. For example, employees who resign could be treated differently from those who are dismissed for misconduct. What are the holding periods for free and matching shares? If free or matching shares are included in a Share Incentive Plan, a holding period of three years must be included. During this period, employees are contractually bound to keep shares in the plan, and must not sell or give away their interest in these shares. A company can provide for a longer holding period - up to five years from the date of award of the shares. This holding period must be the same for all participants in any given award of shares, and may not be increased once the shares have been awarded. No matter how long the holding period, employees cannot leave their shares in the plan if they leave employment during that time. Things to consider when deciding whether to include a holding period of more than three years.
Dividend shares must also be made subject to a holding period of three years. A company may wish to include all or none of these design features in their plan. A company can also decide to include
This should enable the company to design a unique Share Incentive Plan, which operates in a way that supports its strategy and objectives. Companies should consider making their plan rules as flexible as possible when they first implement a Share Incentive Plan, including the possibility of using features that are not immediately going to be used. This will help them to change and develop the way that their Share Incentive Plan works over time, without having to change their plan rules and get the changes approved by us. When a Share Incentive Plan is set up, it is necessary to set up a trust to hold the shares. The legislation details various requirements for this trust, and the duties and responsibilities of its trustees. This section explains some of them. What are Share Incentive Plan trusts and trustees? The trust needs to be
The trust deed must not contain any features that are neither essential nor reasonably incidental to the purpose of complying with the Share Incentive Plan legislation (Para 68(3) Sch 8). This means, for example, that it must not enable employees to receive cash rather than shares out of the plan. Our model trust deed contains all the features that are required by the legislation. Who should the trustees be? The trustees must be a body that is separate from the company setting up the trust and can be either a collection of individuals, or a specially created trust company. They can be employees or directors of the company, but they must act
What are the duties of trustees? The trustees are required by the trust deed to
A plan does not need to operate all four types of share awards, but the trustees cannot use money they receive for other purposes, such as, paying cash bonuses to employees. The trustees have a range of duties that are set out in Part IX Sch 8 FA 2000. What are the trustees' duties to give notice? The trustees must give various notices to participants as soon as practicable
Where any foreign cash dividends are received on shares held on behalf of employees in the trust, the trustees must provide details of any foreign tax deducted from the dividend before it was paid to the employee (Para 70(5) Sch 8). What are the trustees' general duties? Trustees must only dispose of participants' shares, or deal with any rights arising from those shares, on the direction of participants (Para 71(1) Sch 8). The trustees must not sell free, matching or dividend shares during the applicable holding period unless a participant has ceased employment (Para 71(3) Sch 8), subject to the terms of the following parts of the legislation
Can the trustees raise funds to subscribe for rights issues? Yes. Subject to the duty to act in accordance with a participant's directions under Para 71(1) Sch 8 FA 2000, the trustees may dispose of some of the rights arising under a rights issue in order to obtain sufficient funds to exercise the rest of the rights (Para 72(1) Sch 8). What about PAYE and NICs obligations? The plan rules must enable the trustees to operate PAYE when shares are taken out of the plan in circumstances where a PAYE obligation arises (Para 73 Sch 8). This happens where, for example, an employee takes the shares out of the plan before the end of the holding period and the shares are readily convertible assets. The rules should allow the trustee to meet their PAYE obligation by
There are more details on the PAYE and NICs responsibilities arising from a Share Incentive Plan. Trustees must maintain necessary records for their PAYE obligations and those of the participants' employer, which relate to the plan (Para 75 Sch 8). Do the trustees have any other duties? Yes. In addition to those set out above, the Share Incentive Plan legislation allows employees to authorise trustees to accept certain offers for free shares (Para 32 Sch 8). The authorisation can be incorporated into the partnership or free share agreement. What duties are connected with partnership shares? Trustees must hold partnership share money on behalf of employees until they apply it in acquiring partnership shares (Para 39(1)(b) Sch 8). The plan must provide for the trustees to keep any money required to be held by them under Para 39 Sch 8 FA 2000 in an account with an institution authorised under the Banking Act 1987, a building society or a relevant European institution (Para 39(3) Sch 8). If partnership money is held for employees in these circumstances in an interest-bearing account, the plan must provide for trustees to account to employees for the interest (Para 39(4) Sch 8). If there is no accumulation period, the plan must provide for partnership share money to be applied by the trustees in acquiring partnership shares on behalf of the employee within 30 days after the last date for the deduction (Para 40(1) Sch 8). Any surplus money left over after the acquisition of partnership shares must be either
Where there is an accumulation period, the plan must provide for the partnership share money to be applied by trustees in acquiring partnership shares on behalf of employees within 30 days of the end of the accumulation period. Any surplus must be either
Where an employee withdraws from a partnership agreement, any partnership money held on his or her behalf by the trustee should be repaid to the participant (Para 45(3) Sch 8). Where the approval of a plan is withdrawn or the plan is terminated, any partnership money held on behalf of participants must be paid over to those participants (Para 46 Sch 8). What about dividend shares? In exercising their powers in relation to the acquisition of dividend shares, the trustees must treat participants fairly and equally (Para 56(1) Sch 8). If the plan provides for reinvestment of dividends, any excess over the £1,500 limit must be paid to participants as soon as practicable (Para 54(3) Sch 8). The plan must also allow trustees to apply cash dividends in acquiring shares on behalf of participants within 30 days of receipt of the dividend (Para 56(2) Sch 8). What about any surplus dividend money? Any surplus money left after acquiring dividend shares can be carried forward by the trustees, but must be held by them so that it can be separately identifiable (Para 58(1) Sch 8). This money must be paid to the relevant participant within three years of the dividend being paid if
In these circumstances, the money must be paid as soon as practicable (Para 58(2) Sch 8). The trust must issue vouchers showing the amount paid and the appropriate tax credit for the date of that payment where the surplus is paid to the relevant participants (Para 92(2) & 93 Sch 8, as amended under Sch 13). If a participant leaves the plan within three years (apart from the exceptions), the trust must issue him or her with a voucher showing
Step Three. Apply for Inland Revenue approval of a plan Once a Share Incentive Plan has been put together by a company, and the necessary documents drawn up, the company is ready to apply to the Inland Revenue for the approval of the plan. The address is Share Schemes Tel: 020 7438 6718 or 7231 Our Share Schemes service statement sets out the level of service that companies and their advisers can expect to receive in relation to plan approvals. It can be found on our website In helping companies set up a plan, we will look at draft documentation and point out any potential problems at an early stage. If we are made aware of the company's timetable early enough, we will do our best to fit in with it. If there are specific issues which we think might be better resolved by having a meeting than by correspondence, we are happy to meet with companies to take these forward. How to apply for approval of a plan There are two stages in applying for approval. The first of these is informal approval, when we will check the documentation that you send us and tell you if it is capable of approval. If it is not, we will work with you to make it suitable for approval. Checklist We have produced a checklist that enables companies or their advisers to check that the trust deed and rules of a plan contain all of the features that are required by the legislation. Please complete the checklist and send it to us with the other documents for informal approval, to help us process your application more quickly. Informal approval In order to consider a plan for informal approval, we will need to see
Formal approval When we have confirmed that the plan rules and trust deed are capable of approval, the plan can be adopted by the company (for example, at the annual general meeting) and the trust deed stamped. See details on the stamp duty implications of a Share Incentive Plan. When we have sent this confirmation, you can apply for formal approval and submit the relevant documents. What are the relevant documents required for formal approval? One copy of
In addition, you will need to send two copies of
Does a company have to get approval for any changes made to the plan? If a plan is amended after it has received formal approval, it does not necessarily need to be approved again, unless the amendments are to key features of the plan (Para 117(2)(b) Sch 8). Key features are those that are necessary to meet the requirements of the Share Incentive Plan legislation in Sch 8 FA 2000, as amended by Sch 13 FA 2001. Changes to parts of the plan that are not key features do not require our approval. For example, if the rules are changed to reflect a change in the name of the company, prior approval is not required. However, if a change to a key feature is made without our prior approval, it will be a disqualifying event. This means that we can withdraw the approval of the whole plan from the time that the disqualifying event happened (Para 118(1) & (2) Sch 8). What happens if amendments to plan rules are made? If amendments to the rules are going to be made, and they are amendments to key features of the plan, there are two stages for applying for approval to the amendments. They are
If amendments are made that do not involve a key feature, you will need to supply a copy of the amendment to us after it has been made. Does the Inland Revenue have to approve takeover and merger documents? The terms of any exchanges of shares held in a plan, for example, as a result of a takeover, do not need to be agreed in advance with us. When will the Inland Revenue withdraw its approval of a plan? We will withdraw our approval of a plan if a disqualifying event happens (Para 118(2) Sch 8), for example, if
We will notify the company of our withdrawal of approval (Para 118(1) Sch 8). At the same time, we will specify the date on which the withdrawal takes effect. Generally, this will be the date on which the disqualifying event itself occurred, but we have discretion to specify a later date. The tax benefits that employees enjoy under the plan will not be available from that date. This does not affect the treatment of shares in the plan up to that date (Para 118(7) Sch 8). Can a company appeal against withdrawal of approval or refusal to approve a plan? Yes. A company may appeal against our decision to withdraw approval or refuse to approve a plan. To do this, it must give us notice within 30 days of the relevant notice being given to the company (Para 119(2) Sch 8). Appeals will be heard by the Special Commissioners (Para 119(2) Sch 8). The Special Commissioners are independent, full-time members of a tribunal. Their hearings are generally public, although you may ask to have your hearing in private if you wish. The Share Incentive Plan tax return (Form 39) Companies are required to submit annual returns after the end of each tax year. The returns must include details of awards of shares that have been made to employees during that tax year. At the end of the tax year we will send returns to companies with
approved plans. These must be completed and returned to us within
three months of the date on which the return was issued. There are
penalties for failure to submit a completed Share Schemes Tel: 020 7438 6718 This return is in addition to the Self Assessment trust return. Self Assessment trust return The trustees are also required to provide a Self Assessment (SA) trust return for each tax year, which should be submitted to the relevant trust office shown in the table opposite. We will tell the trust office about the plan trust, and they will arrange for the trustees to receive SA trust returns.
For further information contact Inland Revenue Trusts This section explains the process for making awards of shares to employees once the plan has been approved. What happens when shares are awarded? When shares of any type have been awarded to an employee, those shares are held by the trust for the benefit of that employee, subject to the terms of the trust deed and plan rules. The trustees have certain responsibilities to employees who have
interests in the shares in the trust and must give notice to each
participant of free, matching, partnership and dividend shares awarded
to them (Para 70(2) & (3) Sch 8). What control do employees have over their shares? When shares have been awarded, trustees may dispose of an employee's share only if he or she instructs this. An employee may direct the trustees to dispose of his or her partnership shares at any time, though there may be tax implications. Generally, the trustees may not dispose of any employee's free, matching, or dividend shares within the holding period unless the employee leaves the company. The only other situations in which trustees may dispose of shares during the holding period is if a plan terminates (Para 121 (5) Sch 8) or if a participant directs them to
Trustees' PAYE obligations A plan must provide for trustees to be able to discharge any PAYE obligation where shares cease to be subject to the plan early, either by
What happens to money received by trustees? If the trustees receive money or money's worth as a result of holding the shares that have been appropriated to employees, this must be paid to the relevant employees as soon as practicable (Para 71(4) Sch 8). Under a Share Incentive Plan, the market value of the shares must be determined at various times so that tax and NICs can be correctly calculated. A company will need to establish the value of the shares being used in a Share Incentive Plan if there is
What is meant by market value? The market value of any shares is the price they might reasonably be expected to fetch on the open market. If the shares are quoted in the London Stock Exchange Daily Official List the market value is
Prices recorded in the Financial Times are usually halfway (or mid-market) prices. For other companies, it is necessary to agree the market value of the shares with Inland Revenue Shares Valuation Tax and NICs implications of a Share Incentive Plan Participation in a plan by employees can affect their tax and NICs as well as that of their employing company and the tax of the trustees of the plan trust. When income tax arises, PAYE and NICs liabilities may also arise. Income tax & NICs implications for participants The tax and NICs treatment explained here applies to participants in the plan if they are subject to income tax under Schedule E at the time of the award. Partnership share money is taken from participants' pay before tax and NICs are deducted. It does not reduce remunerations or relevant earnings when working out an individual's salary for pensions and annuity purposes. See Partnership Shares. Tax and NICs are not charged when a participant is awarded shares under a plan, or when dividend shares are acquired on his or her behalf. What is the tax treatment of shares ceasing to be subject to the plan? When shares are withdrawn they cease to be subject to the plan if
Participants must take their shares out of the plan if they stop working for the company operating the plan (or group operating the plan, if it is a group plan). When the shares cease to be subject to the plan, there can be tax implications. The general rule is that there is no income tax or NICs to pay when the shares cease to be subject to the plan, provided they have been held in the plan for the full five years required by the legislation. Different amounts may be taxed if the shares have been held for a shorter period. Special rules apply if a participant ceases employment with the company as an involuntary leaver. Identifying which shares come out of the plan If an employee only takes some shares out of a plan, it is important to know which shares have been taken out in order to determine the tax treatment. Shares that went in first must come out first, providing that they are not still within a holding period. Examples Carmel has 100 free shares, which are subject to a three year holding period, and 100 partnership shares. She takes out 100 shares. If
If the free and partnership shares were awarded four years ago but the free shares are subject to a five year holding period, the partnership shares will come out of the plan. How are free and matching shares taxed? Any income tax charge depends on how long the shares have been held in the plan. For example, if the shares are held for
If the shares are readily convertible assets at the time the income tax liability arises, income tax will have to be withheld through PAYE and there will also be a NICs liability. The amount to be included in an employee's earnings for NICs purposes will be the same value that is subject to income tax. Employers will pay NICs if
How are partnership shares taxed? The amount of income tax payable when partnership shares are withdrawn from the plan depends on the length of time the shares have been held in the plan. For example, if shares are held for
The same PAYE and NICs rules apply to partnership shares as for free and matching shares. Partnership share money may be repaid to the participant in certain circumstances. If so, it will be subject to PAYE and NICs if there is
If cash dividends are paid on shares held in the plan and reinvested in dividend shares, they are not liable to income tax in the hands of the participant, nor is the participant entitled to any tax credits on them. Dividends are not subject to NICs so will not arise on dividends that are reinvested in dividend shares. If dividend shares cease to be subject to the plan before three years after their acquisition on a participant's behalf, he or she will be liable to income tax on the cash dividend used to acquire those shares. The participant will also be entitled to the appropriate tax credits. In this situation, the trustees must supply the participant with a statement that includes details of the amount of the dividend and the tax credit. Example Ian wants to reinvest £1,500 worth of dividends from plan shares
into dividend Dividends reinvested (312 x £4.80) = £1,497.60 After 30 months Ian leaves the company. Market value of shares is £5.50 per share = £1,716 Tax credit rate on the date of exit* = 10% of gross amount (net amount grossed up by one ninth) Schedule F liability = £1,500** + (£1,500/9) £166 = £1,666 * The tax credit is that which applies for the date of exit from the plan. ** The value of the relevant dividend brought into charge is the amount of the dividend reinvested plus the return of any amount carried forward and not reinvested. If dividend shares cease to be subject to the plan three or more years after acquisition, the participant will not be subject to income tax on the dividends or the dividend shares. What about cash dividends? Where a cash dividend is paid to the participant without being used to buy dividend shares, he or she is liable for income tax and is entitled to tax credits in the normal way. The trustees must provide the participant with a statement showing details of the cash dividend and the tax credit. In certain situations, there are exceptions to the rules (Para 87(2) Sch 8). For example, a participant will not be subject to income tax if the shares are taken out of the plan early because he or she has ceased employment due to
If the plan provides for the forfeiture of shares when a participant leaves employment, it must be made clear that the forfeiture will not apply in these situations. What about capital receipts? Participants are subject to income tax if they receive capital receipts in relation to shares that are held for them in a plan trust (Para 79 Sch 8). Capital receipts are liable to income tax if the shares in question are
All money or money's worth received as a result of holding the shares is regarded as a capital receipt unless it
PAYE and NICs will apply if the capital receipt is in the form of cash or readily convertible assets. PAYE and NICs implications for employees When operating a Share Incentive Plan, some events may give rise to an income tax charge on the employee. Where there is such a charge there may be a PAYE and NICs obligation. There will always be PAYE and NICs obligations in connection with cash payments to employees. There may also be PAYE and NICs obligations in connection with shares, if the shares are readily convertible assets. Shares are readily convertible assets if they can easily be turned into cash. There is a detailed article on readily convertible assets in Edition 36 (September 1998) of Inland Revenue's Tax Bulletin entitled 'Applying PAYE to remuneration in the form of Readily Convertible Assets'. What about cash payments? The most common situation arises where there is a repayment of money to a participant, which has been put aside to purchase partnership shares. There is an income tax charge and a PAYE and NICs obligation on the payer. Either the trustees or the employer can repay partnership share money, depending on the arrangements that they make. It is for the trustees and employer to decide who will pay the employee when there is a repayment of partnership share money. In most cases it is likely that the employer will make the repayment through the payroll and deduct any PAYE and NICs in the normal way. However, the trustees must assume responsibility for operating PAYE and NICs if
In either of these situations, the trustees must operate PAYE and NICs as if the participant is an ex-employee of the company. Consequently, PAYE should be deducted at the basic rate and the individual is responsible for paying any balance of income tax due under Self Assessment. The booklet CWG2 'Employer's further guide to PAYE and NICs' gives guidance on how to operate NICs after an employee has left. Other situations where PAYE and NICs may apply Exceptionally, there may be some cash taxable on the employee as a capital receipt where both cash and shares are received in connection with a company reorganisation, a takeover or an amalgamation. It is likely that the trustees will pass the cash to the employer so that it can be paid to the employee through the payroll with PAYE and NICs operated. The most common time that a repayment of partnership share money arises, is when an employee leaves employment, or an employee withdraws from the plan, before accumulated partnership share money has been used to buy shares. Repayment of excess deductions from salary relating to partnership shares, or surpluses after buying shares, also create a Schedule E charge and a PAYE and NICs obligation. The employee will have to pay tax and possibly NICs on the money that he or she receives. If money is refunded when he or she has no earnings, for example, during unpaid leave there may not be any tax or NICs due, subject to their earnings and the earnings threshold in the pay period concerned. Equally, if the employee earns above or near the upper earnings limit (UEL) that pay period, then he or she will only have to pay NICs on earnings up to the UEL, although the employer will still be required to pay secondary NICs. The purchase of partnership shares from pre-tax and pre-NICs pay can affect benefit entitlement. The repayment of partnership money and the NICs paid in relation to it can also affect benefit entitlement. The following table illustrates when PAYE and NICs obligations arise in relation to awards of shares. Event Employee takes shares out of plan
Note 1Companies may provide that in a plan involving free or matching shares, employees are required to leave these shares in the plan for a holding period of up to five years before the shares can be taken out of the plan by the employee. A tax charge arises if the employee disposes of his or her interest in those shares before the end of the holding period (Para 31(1)(b) & 82(1)). Note 2 Involuntary leavers are employees who cease employment due to injury, disability, dismissal by reason of redundancy, transfer of employment covered by the Transfer of Undertakings (Protection of Employment) Regulations 1981, a charge of control of the employing company, retirement or death (Para 87). How is the PAYE obligation discharged in practice? Where the PAYE and NICs obligation arises, it is the employer who has to operate PAYE and NICs. Exceptionally, the obligation may fall on the trustees. The Share Incentive Plan arrangements can provide for either
Where the trustees fund the employer, they have the power to dispose of a participant's plan shares to release sufficient funds to cover the tax and NICs liability. The employee then gets the balance of the payment in remaining shares and cash. What about the PAYE liabilities of leavers? The most common situation where an income tax charge arises (and PAYE and NICs will be relevant if the shares are readily convertible assets), is when an employee leaves the company and
The tax (and if applicable NICs) charge arises at the date of cessation of employment, although the PAYE and NICs will be deducted at a later date - when the administration has been completed. If the employee takes his or her shares out of the plan and a tax charge arises, the date on which the charge arises is the date on which the trustees receive the request to transfer the shares. Again, although the tax charge arises on receipt of the transfer notice, the PAYE and NICs will be deducted at a later date - when the administration has been completed. The NICs regulations relating to Share Incentive Plans amending the UK NICs regulations are in the Social Security (Contributions) (Amendment No.6) Regulations 2000. The amendments to the Northern Ireland legislation are in the Social Security (Contributions) (Amendment No.6)(Northern Ireland) Regulations 2000 Capital gains tax (CGT) for participants How is CGT charged on shares held in a plan? Participants are treated for CGT purposes as absolutely entitled to the plan shares once they are awarded to them. A participant who keeps his or her shares in the plan until he or she sells them will not have to pay any CGT on any gains they make, however large (Para 99 Sch 8). What about shares ceasing to be subject to the plan? There is no CGT liability for participants on shares ceasing to be subject to the plan, or on shares which are forfeited under the plan rules (Para 101 Sch 8). An allowable loss does not arise for CGT. What about shares that have ceased to be subject to the plan? If a participant takes his or her shares out of the plan and sells them later, he or she may have to pay CGT on any increase in value after the shares come out of the plan. Taper relief may reduce any capital gain. Individuals can make capital gains up to the annual exempt amount each year without having to pay CGT. For the tax year 2001/2002, the annual exempt amount is £7,500. If the sale price is less than the value of the shares on the date they come out of the plan, there will be a loss for capital gains purposes. This table summarises the tax implications of a Share Incentive Plan for employees. Income tax charge for trustees The trustees are liable to income tax on dividends or other distributions they receive in connection with shares held in the trust, if those shares have not been appropriated to employees. Income in the form of dividends and other distributions is liable to the dividend trust rate, currently 25%, unless the shares are allocated to participants or are disposed of by the trustees within a fixed period from their acquisition (Para 88, as amended by Sch 13). The trustees are also liable to income tax on interest and other income they receive, at the rate applicable to trusts, currently 34%. If, at the time the trustees acquire the shares, any of the company's shares are readily convertible assets (RCAs), the allocation period is two years. If at the time of acquisition none of the company's shares are RCAs the period is
If the shares are not allocated within this time, trustees have to account for tax at the dividend trust rate. The charge arises as soon as it is clear that the shares will not be, or have not been, awarded within the time limit. For example, if the trustees sell the shares, those shares cannot be awarded to employees within the time limit. Tax at the dividend trust rate is due on any dividends received on those shares while the trustee held them. The trustees should account for this tax in their Self Assessment trust return covering the period in which the shares are sold. When shares are held for a period beyond the time limit for relief, a tax charge also arises as soon as the time limit passes. The trustees may be subject to PAYE and NICs obligations in certain situations. When does capital gains tax (CGT) arise? Usually when a trust disposes of shares to a beneficiary, CGT arises on the gain made by the trustees. However, gains arising to the trustees on shares held in the plan are exempt from CGT provided the shares are allocated to employees within a fixed period from their acquisition (Para 98, as amended by Sch 13). If, at the time the trustee acquires the shares, any of the company's shares are RCAs, the allocation period is two years. If, at the time of acquisition none of the company's shares are RCAs, the period is
Where Share Incentive Plan trustees acquire shares from the trustees of an Approved Profit Sharing Scheme, the allocation period runs from the date that the Profit Sharing trustees acquired the shares (Para 103 Sch 8). If the trustees do not comply with these time limits, then any gains on the disposal of the shares may be subject to CGT, in the normal way. If the trustees of an Approved Profit Sharing Scheme transfer shares to Share Incentive Plan trustees, the Share Incentive Plan trustees are treated as acquiring the shares at a cost that gives rise to neither gain nor loss to the trustees of the Profit Sharing Scheme (Para 103 Sch 8). Are trustees liable to stamp duty? The trustees may be subject to stamp duty or stamp duty reserve tax in certain situations. Employers When do employers operate PAYE and charge NICs? Employers of plan participants must pay tax under PAYE, and pay NICs if a Schedule E income tax liability arises on an employee, and at that time, the shares are RCAs. Companies are allowed deductions against corporation tax (CT) by the Share Incentive Plan legislation for certain costs of setting up and operating the plan. They are also allowed a deduction in computing their taxable profits for their costs in setting up a Share Incentive Plan (Para 111 Sch 8). If we approve the plan more than nine months after the end of that period of account in which the expenses are incurred, the expenses are treated as if they were incurred in the period in which the approval is given. No deduction is allowable for costs incurred if, before the plan is approved
Are there any deductions for free and matching shares? Companies are allowed a deduction against their profits for the costs
of awarding free or matching shares. The deduction is equal to the
market value of shares when they are acquired by the plan trustees.
The deduction must be made for the There are some circumstances where no deduction is allowed. If shares are awarded under a plan, and a deduction has been made for the cost of those shares, it is not possible to claim a second deduction if the shares are forfeited and then awarded to another employee (Para 110 Sch 8). What about group plans? Where free or matching shares are awarded under a group plan, the deductions are allowable for each group company in proportion to the number of shares awarded to each company's employees (Para 106(4) Sch 8). What deductions are allowed for partnership shares? A deduction is allowed for the amount by which the market value of the shares at the time that they are acquired by the trustees exceeds the amount of partnership money deducted from a participant's pay (Para 107 Sch 8). The deduction is given for the accounting period during which the shares are awarded. Can a company use shares held in a Qualifying Share Ownership Trust (QUEST)? Generally, no. But, shares held in a QUEST on Budget day 2000 (21 March 2000) can be transferred to a Share Incentive Plan trust without the company losing CT relief that has already been given on the contribution made to the QUEST to buy the shares. This includes shares subsequently purchased by QUEST trustees with funds held at that date. When will deductions not be allowed? No deduction is allowable in respect of awards of shares
Can a company have deductions for running costs? Yes. The company is allowed a deduction for any contributions it makes towards the trustees' costs in running the plan. This excludes the costs of providing the free, matching and dividend shares, as the company will already have claimed a deduction for these. However, a deduction may be claimed for the trustees' other expenses in providing the shares, such as
Is a company allowed deductions if plan approval is withdrawn? If plan approval is withdrawn, we may also withdraw the benefit of any deductions for providing the shares (Para 113 Sch 8). This table summarises the tax implications of a Share Incentive Plan for employers. Issues arising in operating a plan This section deals with particular issues that may arise when you are operating your plan. These generally relate to one-off events that may occur. Can a company impose an administrative charge for shares held after five years? No. Employees may continue to hold their shares in the plan after five years have passed. This will enable them to continue to benefit from CGT relief available to plan shares, but the company cannot impose an administrative charge on employees who choose to leave their shares in the trust. Our view is that this would be a discouraging feature of the plan, and one which was neither essential nor reasonably incidental to its main aim. What if there is a company reconstruction? Company reconstructions include one company taking over another in exchange for an issue of shares or securities, or a company making a bonus issue of shares or securities. The tax reliefs allowable in respect of the existing plan shares can be carried forward into the new shares or securities, provided
The date on which the new free, matching or partnership shares or securities are treated as being awarded is the date on which the original shares they replace were awarded. In the case of dividend shares, the date of acquisition is taken as the date on which the original dividend shares were acquired (Para 115 Sch 8). What about shares acquired under a rights issue? Shares acquired by trustees under a rights issue are treated for all purposes of the plan as if they were identical to the shares in respect of which the rights were conferred. They are treated as being awarded in the same way and at the same time as the original holding of shares. The following conditions apply
How does a company terminate a plan? The company's plan rules can allow it to issue a notice terminating its plan in certain circumstances. The notice must be given three months before termination to
The effect of the notice is that no further shares may be awarded under the plan. The trustees must remove the plan shares from the plan after the expiry of the notice, or, if later, the first date on which shares may be removed without giving rise to a tax charge. The shares may be removed earlier with the consent of the participants (Para 121 Sch 8). Can shares be transferred to Individual Savings Accounts (ISAs) and Stakeholder Pensions? Yes. Employees may transfer shares acquired through a plan into the stocks and shares component of an ISA. There is no charge to CGT on the transfer. However, the transfer must take place within 90 days after the shares ceased to be subject to the plan. The trustees of the plan may give the ISA manager documentary evidence, such as, a copy of the notice of award or acquisition, that the shares have been transferred from the scheme. Otherwise, the investor must provide this evidence. Companies may make arrangements with an ISA manager to offer their employees a maxi ISA or stocks and shares mini ISA into which the shares may be transferred. This ISA can also accommodate other qualifying ISA investments in addition to the shares. The market value of the shares at the date of transfer counts as a subscription to the ISA. This means that the market value of the shares, plus the value of any other subscription to the ISA, cannot currently exceed in a tax year
The employee cannot subscribe to any other ISA (except, in the case of a stocks and shares mini ISA, to a cash mini ISA and an insurance mini ISA) in the same tax year. For further details see our Guidance Notes for Personal Equity Plan (PEP) and ISA managers on our website (paras 6.19ff). Employees can also transfer shares acquired through a plan directly into a Stakeholder Pension. Section Three. Further sources of information and help Some non-tax practical issues This guidance has explained
When a Share Incentive Plan is set up, there are other issues that need to be addressed, which are outside the scope of this guidance. It may be necessary for companies to seek advice in relation to these other matters. Company law issues A Share Incentive Plan involves the use of shares in the share capital of companies. Employers must ensure that the correct procedures are followed when issuing and transferring shares. It is important that the rules and procedures set out in company law and the constitutional documents of the company are followed. If, as an employer, you have any concerns about these aspects, you should seek professional advice. Trust issues This guide has addressed the duties of trustees that the Share Incentive Plan legislation imposes on them. Trustees are also subject to separate legal obligations and requirements, and must ensure that they are aware of and, if necessary, advised upon, these aspects. In addition, trustees have reporting requirements concerning their tax affairs, which are not covered in detail by this guide. Accounting implications Both the company whose shares are used and the trustees may be affected by accounting rules and standards as a result of operating a Share Incentive Plan. If necessary, you should seek specialist advice. Administration Companies should consider whether they have resources in-house to administer their plan. An alternative is to outsource the administration of the plan to a specialist plan administrator. Other issues If you have questions about any of the matters listed above or any other matter in relation to the implementation of a Share Incentive Plan, we recommend that you seek professional advice. Accumulation period A period of up to 12 months during which employees' salary deductions are accumulated in a building society or bank, before being used to buy partnership shares A close company is one controlled by five or fewer participators, or by participators who are directors (s414 Income and Corporation Taxes Act (ICTA) 1988). Dividend shares Shares bought out of dividends earned by employees' plan shares. Forfeiture An allowable restriction on the plan shares requiring employees to
give up ownership of the shares if they leave. Free shares Plan shares awarded free to employees participating in a plan. (see Free shares) Group plans Plans established by a company that controls other companies (the parent) and extends to all or any of those other companies. (see Which Companies Can Set Up a Share Incentive Plan?) Holding period The period that an employee must hold shares in the plan, which must be at least three years for free and matching shares, and must be three years for dividend shares. (see Does a Share Incentive Plan have to include a holding period?) Matching shares Free shares awarded to employees to match their partnership shares. (see Matching shares) Participating company A company that is participating in a group plan. (see What eligability do employees have to meet?) Partnership shares Plan shares bought by employees out of pre-tax and NICs pay. (see Partnership Shares) Readily convertible assets Any assets including shares that can easily be turned into cash. (see When do obligations arise?) A stock exchange that has been designated as a recognised stock exchange by order of the Board of Inland Revenue under s841(1)(b) ICTA 1988. Same terms requirement The requirement that the terms of the award apply equally and fairly to all the employees participating. (see What is meant by employees taking part on the same terms?) The Inland Revenue and Customs & Excise are committed to serving your needs well by acting fairly and impartially We:
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