Agreements to withhold securities

This is a guide for employers and employees who wish to enter into written agreements to allow the employer to withhold or sell securities equal to the employee’s primary NICs liability.

Contents

Relevant legislation

Background

When making a payment of earnings the primary NICs is the liability of the employee and the secondary NICs is the liability of the employer. This is set out in Section 6, sub-paragraph 4 of the Social Security Contributions and Benefits Act 1992 (SSCBA92). In the first instance though the employer has to pay the employee’s primary NICs on their behalf to HMRC (Schedule 1, paragraph 3(1) SSCBA92). They then may recover the NICs from the employee subject to certain conditions.

In making cash payments of earnings the employer can recover the NICs immediately from the payment of earnings. For non monetary payments, such as share based earnings, there are no cash earnings from which the employer can deduct the employees NICs liability when the earnings arise. They therefore have to deduct from the employee’s next available payment of cash earnings. If an employer does not recover the NICs by the end of the tax year it becomes their liability and they cannot recover it from the employee.

Some employers were encountering specific difficulties when making payments of share based earnings, and having to meet the employee’s liability themselves. The problem was particularly acute where the employee received share based earnings close to the date of leaving employment. The Social Security Act of 1998 allowed employers to enter into written agreements to recover primary (employee’s) NICs that they had paid on behalf of their employees on share based earnings. They could enter into these agreements when:

  • an employee had ceased employment and the payment of share based earnings was made after they left the employment but in the tax year of cessation; or
  • an employee had received share based earnings and was ceasing employment in that tax year, and the employer was unable to recover the NICs from the employee’s subsequent monetary earnings.

It was felt that these changes did not go far enough and we did not want to discourage employers from rewarding their employees with share based earnings, both to those earning below the Upper Earnings Limit and those earning above and now paying the additional 1% NICs rate.
The changes made by the National Insurance Contributions and Statutory Payments Act have now extended the circumstances where employers can enter into these agreements. This can now be done for:

  • all employees, including those in continuing employment, irrespective of whether the recovery could be made from the employees’ subsequent monetary earnings; and
  • ex-employees who receive share based earnings in the year that they ceased employment and also if they receive share based earnings in the year after cessation.

This extension of the ability to recover primary NICs by withholding shares does not impinge on the employer’s ability to use the additional powers available for recovery from subsequent cash payment of earnings. Statutory Instrument 2003 No. 1337 removed the limits on the amounts that could be recovered from cash earnings per pay period, and extended the time limit for recovery to the following tax year after share based earnings had been paid. This was subsequently amended by Statutory Instrument 2004 No. 770, which allowed this extension for all security based earnings. If employers and employees prefer to recover by this method then they can continue to do so. Cash earnings means any monetary payment and no distinction is made on how this payment is transferred from employer to employee.

How to enter into agreements

This form of recovery can only be entered into when the employer makes a payment of securities (see below – FAQs). Written agreements between employers and employees are intended to be easy to enter into and therefore we do not specify any particular format or form that must be followed. The agreement between the two parties does have to be in writing to ensure that there is consent on both sides for this form of recovery to be made. The agreement can either state that the employer will sell, or withhold, an amount or percentage of shares to settle the NICs liability. If the employer sells or withholds shares and their value is more than the employee’s NICs liability, the excess amount should be reimbursed to the employee.

As with form of earnings, the employer has to pay the employee’s NICs to HMRC when the payment of security based earnings has been made. The employee does not directly pay HMRC their liability.

Frequently Asked Questions

What type of earnings can be covered by these written agreements?

Royal Assent was granted to the National Insurance Contributions and Statutory Payments Act 2004 (the Act) on 13 May 2004. Regulations made under the new powers came into force on 22 September 2004 allowing agreements to be made for all earnings covered by the definition of 'securities'. Securities covers:

  • shares
  • company loan stock
  • government gilts
  • a number of specialised financial instruments.

It does not cover:

  • cash
  • cheques
  • leases.

A full list of all payments coming under the definition of securities are at Section 420 of the Income Tax (Earnings and Pensions) Act 2003 as amended by Schedule 22 to the Finance Act 2003.

When can a written agreement between the employer and employee be entered into?

Written agreements can be entered into at any time up to the day that the security based earnings are paid. If the employer has granted share options already, but where NICs are not due until after the regulations came into force on September 22 2004, the employer would be able, with the employee’s agreement, to use this provision to recover the primary NICs due when it arises.

What format does the agreement have to take?

There is no set format that the agreements have to take other than the employer must have prior consent to recover the primary NICs by withholding shares, and this consent must be in writing. There is no prescribed form for the agreement it does not require prior HMRC approval.

Employers can include the written consent as part of the terms and conditions of a share award / option grant. To meet the requirement that the employee must give written consent, the employer should ensure that the employee makes some form of positive written acceptance of the award/ grant, including it’s terms and conditions.

What happens if the employee refuses to enter into an agreement?

If the employer has already granted securities options and does not have a written agreement from the employee to withhold shares, and the employee refuses to enter into one following the introduction of the legislation, they cannot recover by this method.

The employer will still be able to recover the NICs from the employee’s future cash earnings up to the end of the tax year following the year in which the liability arose. The employer does not require the written consent of the employee to do this.

Do I need to produce a certificate showing the amount that has been deducted by this method?

You will need to give the employee a statement of all deductions made from any payment of earnings, so that the employee can see how many of their shares have been retained or sold to cover the liability. This is covered in legislation at Section 8 of the Employment Rights Act 1996.

Can you show me how a recovery can be made?

An employer grants an option over 10,000 shares to an employee. At the time of the grant the shares are worth £5 each which is the exercise price in this example. At grant the employer enters into a written agreement with the employee to withhold an amount of shares equal to the primary (employees) NICs liability due when the payment of earnings arise.

The employee exercises the option three years later when the shares are worth £10 each. The share-based earnings are, therefore, £50,000. The calculation is shown in the illustration below

The employee is already paying primary NICs up to the Upper Earnings Limit (UEL) on their other earnings so the liability on these earnings will be at the rate above this level, which is 1%. The liability that the employer pays to HMRC on the employee’s behalf is calculated as follows:

Market Value of shares at exercise

(10,000 x £10)

=

100,000

Exercise price

(10,000 x £5)

=

50,000

Share-based earnings

(100,000 - 50,000)

=

50,000

NICs on 50,000 @ 1%

 

=

500

The employer, therefore, needs to retain 50 shares (based on the value at exercise of £10 each) in order to recoup the primary (employees) NICs of £500, which they have paid on the employee’s behalf.