Allowing employees to bear the employer's national insurance arising on share option gains

Background

Changes introduced in the Child Support, Pensions and Social Security Act 2000, which gained Royal Assent on 28 July, allow employers to ask their employees to bear the employer's (secondary) NIC arising on share option gains. There are two ways in which this may be achieved:

Agreements and elections can only be made for gains on rights to acquire shares. These usually take the form of a share option. The gains are usually made through the exercise of the share option but can also be made, for example, when the employee is offered cash to cancel the option.

Method 1 - agreement for employee to pay employer's NIC

The NIC legislation does not allow the employer to ask the employee to pay any part of his secondary (employer's) liability for NIC. However, the legislation has now been amended to provide an exception to this rule. Employers and employees may now agree that the employee will bear some or all of the employer's NIC on share option gains.

What share options can agreements cover?

Agreements are only valid if they were made on or after 19 May 2000. They can cover any share option, which has been granted to an employee, but they will not be valid for any gains that were made prior to the 28 July 2000.

Agreements can be made in respect of any share option where a NIC liability may arise on the share option gain. This includes qualifying options for the purposes of Enterprise Management Incentives.

What NIC can be recovered from the employee under an agreement?

The agreement may cover some or all of the employer's NIC that may arise on share option gains. For example, an agreement may be for the employee to pay 75% of the employer's NIC liability, or any employer's liability above a certain monetary amount.

What format should the agreement take?

That is for the employer to agree with the employee.

How should the NIC be recovered from the employee?

It is for the employer and the employee to agree how the employee will reimburse the employer. Many employees sell some of their shares when they exercise the share option to meet their income tax liabilities. One way of recovering the employer's NIC from the employee may be to extend this arrangement.

How does an employee receive the income tax relief where an agreement exists?

Finance Act 2000 introduced income tax relief for the employee on the amount of the secondary NIC that he pays on the share option gain, provided that it is paid within 60 days of the end of the tax year in which the gain occurred. When the gain is made income tax will be collected through PAYE in the usual manner. Employers will be able to operate PAYE on the amount of the taxable gain reduced by the amount of any relief likely to be available.

Example

Employee exercises an unapproved share option on 1/12/00 and makes a gain of £1,000. She has agreed with her employer that she will pay all of the employer's liability for secondary NIC.

Employee earns above the employee's upper earnings limit.
Employer's NIC is 12.2% of £1,000 = £122.

Employee pays the employer £122 on 7/12/00.

Income tax is collected through PAYE.
Amount on which PAYE is operated is £1,000 - £122 = £878.

What happens if the employee does not reimburse the employer within 60 days of the end of the tax year in which the gain arose?

Employees are not entitled to income tax relief on the amount of the secondary NIC if they have not paid it within the time limit. If they have not met the deadline and PAYE has been operated on the taxable gain net of the secondary NIC amount, then the employee will be required to pay back toHMRC the income tax relief already given.

Method 2 - An election to transfer the liability for secondary NIC on share option gains to an employee

Legislation has been introduced which will enable an employer to make an application to HMRC for approval of an election to transfer the liability for secondary NIC to the employee. If approval is obtained, the employer and employee can jointly elect to transfer some or all of the secondary NIC liability arising on a share option gain to the employee. Elections can only be made when HMRC have given notice that they are satisfied with the form of the election and that the accompanying arrangements will result in the timely payments of secondary NIC by the employee.

The ability to make an election to transfer the liability has been introduced to overcome accounting difficulties for companies that report in the US, which would otherwise arise if the employer simply recovered the secondary NIC from the employee under Method 1.

Model Joint NICs Elections

We have now provided model elections for employers and practitioners who are considering submitting an election for HMRC approval.

There are two formats of the election as allowed for in the legislation:

The models produced here show the minimum we would expect to see in order to give formal approval. If you decide to use either format you must still seek HMRC approval.

Guidance notes for using the models

Section 1 - between

An election must be made jointly between the secondary contributor, (the employer) and their employee. It is important to show this at the beginning of the joint election. Give enough information to identify which parties are entering into the election.

There may be occasions when the company granting the options may not necessarily be the secondary contributor. In these cases the Revenue will accept elections providing the company is authorised to act on behalf of the secondary contributor and that this is clearly stated in the election. We will still require details of the secondary contributor, (the employer) to be shown in the joint election.

Example

Company XYZ, whose Registered Office is at [insert address and Company Registration number], is authorised by ABC, the Secondary Contributor, whose Registered Office is at [insert address and Company Registration number].

There will often be occasions when a joint election will be submitted for a group of companies where there is more than one secondary contributor. In these cases rather than provide us with a separate election for each secondary contributor involved you are advised to submit just one election but provide full details of all the secondary contributorswho will be using the election.

Section 2 - purpose and scope of election

Part (a)

The options to be covered by the election need to be identified. They will either relate to a specific option grant or cover a period in which the options may be granted. It is for this reason that the model election provides you with 3 alternative dates.

  1. On [DD/MM/YYYY] - relates to a specific grant of options. An election that only shows this date will only allow the transfer of employers NICs for gains arising from those particular options. This will mean that another election will need to be entered into between you and your employee if you want to grant any further share options.
  2. Between [DD/MM/YYYY] and [DD/MM/YYYY] - this allows you to include options already granted from 6 April 1999 (providing no option gain has already occurred) to an end date determined by you. The last date could be the date that the share plan ceases or any other date.
  3. After [DD/MM/YYYY] - you may decide that new employees starting with the Company will be asked to enter into the joint election from the date of their employment but the election will only be valid for share options that are actually granted to them.

Part (b)

This refers to the legislation under which an election can be made which is Paragraph 3B(1) of Schedule 1 of the Social Security Contributions and Benefits Act 1992.

Part (c)

This is a statement that the purpose of the election is to transfer the liability of employers NICs payable by the employer to the employee.

Part (d)

The regulations require that you identify the extent of the transferred employers NICs liability. We have provided three alternatives that you may wish to choose from:

  1. the whole of the secondary liability - this is the total liability that would be payable by the employer based on the employers NICs rate in force at the time of the option gain occurring.
  2. [X %] of the liability - you may decide that the liability for employers NIC is split between you and your employee.
  3. The liability on gains in excess of [£X] - this is similar to the previous choice but instead it is based on a monetary value.

Example

You may decide that you as an employer are prepared to meet any employer NICs liability on say up to the first £0.50 gain per share. Any employer NICs liability on the gain in excess of that amount will then be transferred to the employee to pay as part of the joint election. Also acceptable would be the situation where you considered paying the employer NICs due on the first £500 of an option gain and any excess over that amount would be transferred to the employee.

Option gains will not only result on the exercise of an option but also from their assignment, release or cash cancellation. If you decide that it is not appropriate to include these other situations then the force of the election will be limited only to gains by way of exercise. This means that you will still remain liable for employers NICs due on any gains from the assignment, release and cash cancellation of the options covered by the election.

Part (e)

This paragraph is not compulsory. However, any election which includes it will indicate to HMRC that the secondary contributor will be aware when an individual, who is no longer required to be paid by the Company, will continue to be subject to the arrangements for payment of the employer NICs.

If you decide to leave this out of the model election, then you are required to send in a covering letter. This letter must explain how you will identify when individuals have made option gains and explain the arrangements that are in place to ensure that payment is received by the Company and will be paid to HMRC on time.

Failure to explain this will lead to approval being withheld until satisfactory evidence is provided.

Section 3 - arrangements for payment of secondary NICs

Before formal approval can be given we need to be satisfied that suitable arrangements are in place for the transferred NICs to be paid to HMRC in time. It is important that with any application for NIC election approval, careful consideration is given to the arrangements being submitted to us will work and that plans are either in place or have been drawn up to recover the transferred employer NIC from the employee within the required time scale.

Section 4 - duration of this election

Elections must contain all 4 bullet points.

Section 5 - Declaration

Must be signed and dated by both the secondary contributor, (the employer) and the employee.

In the case of the two-part format, Part A is signed by the employee and Part B by the employer.

Two-part joint election

We have introduced a two-part joint election to help large companies that want to enter into elections with a large number of employees.

The two-part model is the same as the single joint election except Part A is to be completed by the employee and Part B by the secondary contributor, (the employer). Also, each part indicates the other party has signed a counterpart joint-election.

Please see Elections - questions and answers