Employer's NICs on Unapproved Options

The Child Support, Pensions and Social Security Act 2000 included provisions in response to companies' concerns about the application of employer's National Insurance Contributions (NICs) on unapproved share option gains.

The provisions have been designed to alleviate the concerns that companies had about the potential unpredictable NICs liability where share prices are highly volatile and the effect this may have on their reported results and cash flow.

Finance Act 2000 also contains provisions to deal with the income tax effects of these NIC changes on the employees.

In the Pre-Budget Report on 8 November, the Chancellor announced a further measure to address companies' concerns about a potentially unpredictable NICs liability.

This page contains answers to frequently asked questions and links to further information.

Contents

Frequently Asked Questions

Q. What were companies concerned about?

A. Before April 1999 NICs was payable on the grant of share options, but only if the options were granted at a discount. Any charge was limited to the discount. However, these old rules were unfair because the charge did not reflect the gain made when the option was exercised nor that it might never be exercised.

In 1999 the law was changed to make NICs payable on the gain made when the option is exercised, assigned or released. As a result, the NICs charge was on the same basis as the PAYE tax charge. This change was part of the Governments policy for tax and NICs alignment.

However, some companies expressed concern that the secondary NICs charge is unpredictable, and that this would cause problems in drawing up their accounts. Under accountancy rules, they are required to make a provision in their accounts for the anticipated NICs liability on share options, based on the market price of the shares on the date that they prepare the accounts. Employers expressed concern that their exposure to an unpredictable NIC liability could put at risk their investment strategies and even make some technically insolvent. This has been of particular concern for small companies with limited cash flow and volatile share prices.

Q. What will the provisions in the Child Support, Pensions and Social Security Act do?

A. The new provisions in the Child Support, Pensions and Social Security Act:

  • Extend the statutory bar preventing employers recovering NICs from employees in respect of Class 1A and Class 1B NICs.
  • Allow the employer to recover the whole or part of any secondary NICs payable in respect of a unapproved share option gain from the employee (subject to the agreement of the employee).
  • Where a joint election has been made by the employer and the employee which has Inland Revenue approval, the amendment allows the whole or part of the employer's secondary NICs liability to be transferred to the employee.

Q. How does this change help companies?

A. This change provides a technical solution to the problem by eliminating the unpredictability for employers, and should also solve the cash flow problem for small companies by allowing the person who has the funds to pay the secondary NICs: i.e. the employee.

Q. How will agreements to recover the secondary NIC work?

A. Agreements to recover the liability must be voluntary agreements between the employer and employee. It has been possible to make agreements since 19 May 2000 but they did not have legal force until the Child Support, Pensions and Social Security Bill received Royal Assent on 28 July 2000. Agreements can relate to options granted after 5 April 1999 (provided the NIC liability did not arise before 28 July 2000).

Further details are available from Allowing Employees To Bear The Employer's National Insurance Arising On Share Option Gains

Q. How will elections to transfer the liability work?

A. Employees and employers can elect to transfer the secondary NICs liability to the employee to overcome accounting difficulties in the US with a 'recovery approach'. Under this arrangement the employee, rather than the employer, will be liable for any secondary NICs arising on share options gains covered by the election.

In order to make an election, the employer must seek prior approval from HMRC. This approval will be given for both the form of the election and the arrangements made for securing that the liability transferred by the proposed election will be paid on time. The employer may have more than one approved election format or approved arrangement. Once approval has been obtained employees and employer may make joint elections - again, this is voluntary and so both the employee and the employer must agree to the election.

As with the agreement to recover, the election can cover an absolute amount, an amount above or below a prescribed figure or a percentage of the secondary NIC arising on the share option gain. We do not prescribe the format or content of the election. Employers can make the election an integral part of the option contract if they wish to do so.

HMRC can refuse approval if it appears that adequate arrangements to make sure that the liability will be met have not been made, or if HMRC feels that it does not have enough information to determine this.

An election continues in force until:

  • it ceases to have effect in accordance with its terms
  • it is revoked jointly by both parties; or
  • the approval of the election is withdrawn by HMRC in relation to options not yet granted.

Further details are available from Allowing Employees To Bear The Employer's National Insurance Arising On Share Option Gains

Q. Will the employee get tax relief?

A. Yes. There is special tax relief available for employees who meet their employer's NICs liability. This will reduce their headline rate of tax for the exercise of unapproved options from 52.2% (40% income tax + 12.2% employer's NICs) to 47.32% for a higher rate taxpayer and from 35.2% (23% income tax + 12.2% employers NIC) to 32.39%.

Q. Will the election work under US Generally Accepted Accounting Principles?

A. Yes. Our advice is that an election to transfer the legal liability can be structured in a way that does not trigger a charge to a company's profit and loss account as required under the variable plan accounting provisions included in the US Generally Accepted Accounting Principles.

Q. When did the new rules come into effect?

A. The NICs and Income Tax provisions came into effect when the Child Support, Pensions And Social Security Bill and the Finance Bill 2000 respectively received Royal Assent on 28 July 2000. They can apply to all unapproved share options granted on or after 6 April 1999 where a gain had not arisen before 28 July.

Q. Why not revert to the old rules?

A. The old rules were unsatisfactory because the charge did not reflect the gain made when the option was exercised nor that it might never be exercised. They were also deliberately used by some firms to pay large bonuses to directors and highly paid employees free of National Insurance.

Q. Where can I get further information about unapproved options?

A. Information on schemes and arrangements that have not been approved by HMRC is in our Employment Related Securities Manual.

Q. Can I enter into one of these arrangements now?

A. It has been possible to enter into a voluntary agreement that allows recovery of secondary NICs since 19 May 2000 but it would have had no legal force until Royal Assent of the Child Support, Pensions and Social Security Act on 28 July. However, an agreement could not apply to any liabilities that arose before Royal Assent of the Act on 28 July.

For a joint election you will need Inland Revenue approval. Click here for details of the joint election process. Once approval has been received an election can be made to cover any option granted to the employee after 5 April 1999, provided that the liability for secondary NICs did not arise before 19 May 2000. Companies who wish to grant options now may therefore wish to agree with the employee that the option grant is conditional on such an election being made after approval is received.

Q. How to make agreements and elections

These are the details on how to make agreements and elections.

Further information

A news release was published on 19 May 2000 announcing the measures in the Child Support, Pensions and Social Security Act 2000 and Finance Act 2000.