Following the 2016/17 deadline for the reporting of employment related securities, we have noticed an increase in the number of penalty notices received this year in relation to companies who have failed to comply with their filing obligations. This has always been a complex area and it has become even more burdensome in recent years since it became mandatory to file returns online. This article aims to clarify certain aspects of employment related securities for those practitioners and companies who come across them.
What are employment related securities?
The rules governing the taxation of employment related securities can be found in ITEPA 2003, Part 7. Simply put, an individual who is able to acquire shares in a company by reason of their employment will have acquired employment related securities.
This is far wider than it may appear at first sight: someone acquiring shares in a company that is their employer, has been their employer in the past or, at the time that they acquire the shares, is their prospective employer will be deemed to have acquired them by reason of their employment with the company.
In practical terms, this will mean that anyone who founds a company and becomes a director of it will be treated as having acquired employment-related securities and will be subject to the regime of charges in ITEPA 2003, Part 7.
The only exemption from this regime is where an individual acquires shares from an individual, or from a company that is a close company under the control of that individual, and has acquired them in the ordinary course of their domestic, family or personal relationships. Needless to say, HMRC interpret this exemption extremely narrowly and are unlikely to accept that shares given to employees who just happen to be ‘golfing buddies’ will fall within it.
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Shares can be acquired in a number of ways that fall within the employment related securities rules, some ways not as obvious as others. For example, by way of:
- Unapproved share options
- Approved share options, such as under the Enterprise Management Incentive Scheme or Company Share Option Plan
- Certain share for share transactions
The employee who acquires the shares is subject to income tax where the market value of the shares is more than the price they paid to acquire those shares. If those shares are readily convertible assets, national insurance will also be liable on those shares via the PAYE function.
Most securities that are acquired in private companies will have a depressed value for a number of reasons. Examples include having to forfeit the shares on the eventual sale of the company or the right to dispose of the share is restricted.
Restricted securities can be subject to income tax on a number of occasions:
- on the acquisition of the shares, the charge to income being on the difference between the restricted market value of the shares and the price paid;
- on the date that the restrictions are lifted, with income tax being charged on the proportionate difference between the unrestricted market value of those shares less the restricted market value which has already been subject to income tax; and
- on the sale of the restricted securities, if all of the restrictions have not lifted.
The risk is that by the time the restrictions have been lifted, the proportionate difference between the restricted and unrestricted market values may be significant in cash terms as the shares have increased in value and that an employee expecting to realise capital gains on the sale of shares can end up with a PAYE and NIC liability on at least a proportion of his or her gains.
This can be avoided by the employer and employee signing a joint election under ITEPA 2003, s431 to dis-apply the restrictions, which will mean that the value subject to income tax at the time that the shares are acquired will be the difference between the unrestricted market value of the shares and the price paid.
The advantage of this is twofold. Firstly, there will only be one occasion of charge to income tax, being the date of acquisition. Second, the subsequent growth in the value of the shares following acquisition will be subject to capital gains tax rather than income tax. If the shares meet the conditions for entrepreneurs’ relief, they will subject to tax at 10% as opposed to 42% or even 47% (including NIC).
The joint election must be signed and submitted to HMRC within 14 days of the acquisition of those shares.
Filing requirements and deadlines
Prior to the 2014/15 tax year, employment related securities were reported to HMRC on a paper form, commonly known as Form 42.
From 2014/15, the report must be made online. HMRC now provide various online templates in an ODS format, with separate templates for shares acquired under one of the statutory share schemes and shares acquired under an ‘unapproved’ scheme.
The employer will need to register to use HMRC Online Services. Those who have an active payroll may already be registered, but if an employer does not have an active payroll, it can take up to 7 working days to receive login details.
The adviser to the employer will then need to register for the Employment Related Securities service, for which HMRC will issue an activation code by post in order to activate the service, this can take up to two weeks to complete.
While accountants and tax advisors can register as agents on behalf of the employer, they are unable register schemes online, only submit returns on schemes that have already been registered by employers.
The filing deadline for the online submission of the annual return continues to be the 6 July after the tax year in which the shares were acquired.
If an annual return is filed late, a £100 late filing penalty will arise. The penalty will increase to £300 if the return is still outstanding 3 months after the filing deadline and a further £300 will arise if it is 6 months late. After 9 months, daily penalties of £10 may also be charged.
In addition, if a return has been completed incorrectly deliberately or carelessly, HMRC can charge a penalty of up to £5,000.
The introduction of online filing for employment related securities has seen a number of employers been subject to late filing penalties. There are a couple of reasons for this.
Firstly, when an employer registers online for employment related securities with HMRC, and registers a scheme, HMRC expect a return to be submitted annually, without regard to the transactions that have been carried out.
For example, a share for share exchange occurs: this is a one off transaction that requires reporting in the year that it takes place, there are no further transactions planned. The client goes away believing that they have satisfied all of their reporting requirements, not realising that an annual return must be filed for the following tax year unless notice is given (again online) that the scheme has been closed. The filing deadline passes unnoticed and the first the employer becomes aware of a filing obligation is when a penalty notice arrives in the post.
Secondly, the online system is set up in such a way that the agent’s influence is diminished due to the requirement for the employer to register the establishment and closure of schemes. In a number of instances this has meant that filing obligations are being missed by both the company and their agent, resulting in needless penalties.
Companies and their agents need to find a way to communicate better to avoid such problems arising. The following steps are suggested:
- Firstly, where an annual return is required, complete it and file it well before the filing deadline. Even if it is only a nil return, tick the box to indicate that it is a nil return and get it submitted online.
- Close down schemes that have been set up where no further reportable events are expected in the future. Agents cannot do this, only the employer can. To do this, go online and select ‘View Schemes and arrangements’. Select the relevant scheme and provide a date of final event.
- Accountants and tax advisors need controls in place to monitor this compliance function and to communicate this effectively to affected clients. For example, accountants who deal with their clients’ company secretarial matters should be able to generate a report which shows all share issues in a tax year. Generate these reports after each tax year and identify affected clients who have a reporting obligation. Contact them at the earliest opportunity as you will need time to set them up properly with HMRC before annual returns can even be filed online. The 3 months from the end of the tax year to the filing deadline passes quickly!
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