The ‘loan charge’ has taken effect today. Those beneficiaries of ‘EBT loan schemes’ who have by now failed to settle, or at least register with HMRC their willingness to agree to settle, all unpaid liabilities to income tax, NICs and, if appropriate, inheritance tax arising from re-directed earnings and earlier ‘disguised remuneration’ charges (on, for example, any post 5^th April 2011 earmarking and/or making of a loan) must now take action to ensure that income tax and NICs are properly accounted for.

Unless, before 5 April 2019 the client and/or the employer company (a) registered with HMRC a clear intention to settle all related earlier tax liabilities and (b) provided all relevant information to HMRC, the employer company is liable to account for the tax and NICs on the amount of any loans and ‘quasi-loans’ outstanding (or deemed to be outstanding) by 19th April (by post) or 22 April (online) and to report the loan charge amount to HMRC via RTI in April 2019 using an Earlier Year Update submission (available from 20 April 2019). The relevant individual is also be obliged to deliver to HMRC an information return by 30 September 2019.

This information requirement, and a description of the rules affording a degree of mitigation against double taxation which apply when determining the amount of tax payable upon the loan charge and when subsequent ‘relevant steps’ are taken within the scope of the ‘disguised remuneration’ rules, are the subject of my article published in Tax Journal on 5^th April 2019. See:

https://www.taxjournal.com/articles/after-the-loan-charge-bites-calculations-and-information-requirements

[Note, if you do not subscribe to Tax Journal, I shall be permitted to reproduce the article as from Sunday 14^th April.]

At a reception following the ESOP Centre’s British Symposium on 7^th March 2019, I had the privilege of accepting, on behalf of Xtrac Limited, the 2018 award for the ‘Best All-Employee Share Plan in a Smaller Company’ in recognition of that company’s efforts and achievements in promoting share ownership amongst all its employees. Since it was founded in 1984, the company has over the years received many awards for its success in the design and manufacture of high-precision gearboxes and powertrains for Formula 1 and other motorsports, an industry in which it is a world leader. In 1997 its founder, Mike Endean, retired and sold the company to its management and an employees’ trust. Since then, the company has grown, from around 100, to currently over 360 employees and apprentices and a turnover in the region of £50 million. Its state-of-the-art factory and design facility in Thatcham opened in 2000, and a major extension was recently inaugurated by the Prime Minister, Theresa May. Although now substantially owned by a private-equity fund, the company is a shining example of how a policy of positively encouraging employee share-ownership has contributed to the group’s success and positive employee engagement.

Xtrac is, perhaps, unique in having, since 1997 and whenever possible having regard to its ownership structure from time to time, made use of every recognised type of employee share scheme. For so long as it was ‘independent’, Xtrac operated a (pre-2000) ‘Inland Revenue-approved profit-sharing scheme’, as well as Inland Revenue-approved ‘savings-related’ and ‘company share option (“CSOP”) schemes’. Following the introduction of “Share incentive Plans” (“SIPs”) in 2000, the company has established a series of such plans under which shares have been regularly awarded as ‘free’ shares as well as, on occasions, having also been offered for purchase out of pre-tax earnings (i.e. gross earnings before tax) as ‘partnership shares’. Some employees have, in the past, benefitted from EMI (“enterprise management incentive”) and ‘unapproved’ share options, as well as joint share ownership arrangements and so-called ‘growth shares’. Crucially, perhaps, participating employees have been afforded opportunities to realise the value of their shares, to which they have contributed by their labours, both when they retire from service and on the occasions when investment by third party private equity funds, and the inevitable corporate reorganisation, has afforded the opportunity for employees to do so. This has, in many cases, allowed employees to realise relatively substantial capital amounts, either in a single lump sum or, as appropriate, through a series of payments over time. Consequently, employees have recognised and enjoyed additional benefits in working at Xtrac when compared with the more limited opportunities for financial participation in other companies. Even after the most recent change of ownership of the group in 2018, participating employees remain holding financial interests through loan notes held, for the most part, within the tax-free envelope of the SIPs under which shares were first awarded.

Share scheme advisers may be interested in the fact that, unusually, the Xtrac Employees’ Trust first established in 1997, and used to warehouse shares, award them pursuant to SIPs, and transfer them in satisfaction of share options, as well as buy-back or receive shares sold or forfeited by leavers, is a UK – not an overseas-based – trust. The trustee is a single corporate trustee (a company with a share capital) which is wholly-owned by what is now an intermediate holding company within the Xtrac group. Its directors include both employees’ representatives and an individual (me!) who has only a non-beneficial interest in the financial success of the group. At all times, the Xtrac share schemes, including the SIPs, have been self-administered by an officer of the company without the need to engage third-party plan administrators. Although the company’s use of tax-favoured schemes has over the years thrown up a number of technical issues exploring the scope and application of the tax legislation, it is fair to say that all of the arrangements made by the company to take full advantage of available tax reliefs have operated as intended by government and HMRC and, accordingly, the recognition accorded by the ESOP Centre award is well deserved. Xtrac is an example to others of how, used appropriately, employee share ownership benefits the company itself and all its shareholders. Congratulations to Xtrac.

The period for consultation in response to “The Taxation of Trusts: A Review”, published by HMRC on 7 November 2018, ended at the end of February 2019. The Share Plan Lawyers’ Group has taken the opportunity to submit a number of suggestions for change in the light of practical experiences in the application of the legislative provisions to employees’ trusts established for normal commercial purposes, rather than as part of a tax avoidance scheme.

1. The requirements of s86 IhTA have long been ‘honoured in the breach’ and there is a need for it to be recast so as to make clear that a discretionary settlement for a class comprising bona fide employees (including ‘workers’) of any company which is from time to time a member of the 51% group of companies of which the settlor company is the parent, will be a ‘s86 trust’. This should be regardless of whether the employer company carries on a “trade or profession or undertaking”, or of the fact that different members of the same group might carry on disparate trades or undertakings. This should be an additional test which, if satisfied, means that s86 may be taken to be satisfied. Put another way, a trust for employees of a group of companies of which the settlor is the ultimate parent, should satisfy the gateway requirements of s86 regardless of the activities of that group or of any particular employer member of it.

Corresponding and consequential amendments would be needed to ss28 (so as to add wording similar to that in ss13(1)(b)) and 75 so as ensure a consistent approach.

2. There is a strong case for allowing an employees’ trust intended to satisfy s86 to be drafted in a manner which allows for the interposition of a new holding company (with no substantial change of ultimate ownership) so that, thereafter, the class of beneficiaries may be taken to include (also) employees of the new holding company – allowing for a hive-up of the business and a continuity of the use of the trust. The existing position is that if such a new holding company is interposed, and the trade hived-up, the old holding company must be kept in existence solely for the purposes of ensuring that the trust may be applied to benefit (existing, but not new) employees of the hived-up trade and/or employees of other subsidiaries of what was the old group holding company. If the old holding company is wound up, there will then be no employee of that company or of any former “subsidiary” of that company. Keeping in place the old holding company in this situation is an unnecessary administrative burden.

3. In s13, sub-sections (4)(a) should be amended so as to make clear that a power to apply the trust fund in the provision any benefit paid out to, or for the benefit of, a beneficiary which gives rise to a charge to income tax on the part of that beneficiary as either a general earnings charge, or under Parts 7 and/or 7A of ITEPA will not mean that the requirements of s13 are not satisfied. Whilst HMRC appear to accept that a power to make a payment which gives rise to a charge to income tax, such as a one-off transfer of shares, is within ss(4)(a), the exemption in that sub-section could be read as applying only to payments which, as a matter of general law, are in the nature of income, as opposed to payments of a capital nature (e.g. an award of shares) which happen to be brought into charge to income tax under specific legislative provisions. Such a clarification would allow the larger close companies to make contributions without fear of triggering s94 charges where the purpose is to allow the trust to satisfy contingent share awards and L-TIP awards.

4. Sections 72 (transfers out of a s86 trust) and s65 (transfers out of a non-s86 trust) need to be amended so as to make clear that both a transfer of shares and the grant of an employment-related securities option in circumstances in which (a) a charge to income tax arises either as a general earnings charge or under Parts 7A or 7; or (b) s425(2) applies to the acquisition; or (c) the option is acquired by a member of the class of beneficiaries and s 475(1) applies to the acquisition (i.e. adopt the wording of the DR exclusion in s554N(1) and(2)). In other words, it should be made clear that the grant of a discounted option, or transfer of shares at an undervalue, does not trigger an ‘exit charge’.

5. Is there a case for seeking an exemption from inheritance tax for a gift of shares into a s86/s13 employees’ trust by an individual shareholder which is less than a controlling interest? Why should a minority shareholder wishing to gift or bequeath shares to an employees’ trust should not do so without having to rely on the availability of BPR?

Capital Gains Tax issues
6. There is a need for s239ZA to be amended so as to secure that no chargeable gain arises to the trustees upon a transfer of shares to an employee whether or not he or she gives any amount of consideration for the shares, and whether or not he or she is an ‘excluded participator’.

The principal reason why employees’ trusts are established offshore is the fact that onshore trustees remain at risk of charges to CGT if, for example, an employee purchases shares from the trust at an undervalue. Such a disposal by an offshore employees’ trust is normally outside the scope of UK capital gains tax. It is difficult to see any reason of policy why the tax treatment of onshore and offshore trustees should not be put onto a ‘level playing field’ so as to at least avoid the existing positive discrimination in favour of going offshore. Removing the justification for establishing an employees’ trust offshore would significantly reduce the cost to UK companies, and simplify the process, of using an employees’ trust to warehouse shares intended to be used to satisfy employee share awards and options.

Income tax: dividend income
7. Whilst it is a term of most employees’ trusts that dividends are waived on shares held, employees to whom deferred share awards and options are granted being paid corporation tax-deductible bonuses in lieu of dividends paid in the award period, that is not always the case. If dividend income is not waived, it is suggested that there should be both (a) an exemption from income tax, in the hands of the trustees of an employees’ trust if such dividend income on shares in the employer company (or its holding company) is distributed within, say, 3 months of receipt, on an ‘all-employee’ basis to qualifying employees and former employees; and (b) a legislative provision that such distributions be treated for all tax purposes as dividend income of the employee recipients.

This would be ‘self-policing’ in that the extent of the relief afforded is dependent upon the availability of distributable profits and the size of the trust’s holding of shares. To prevent abuse, it would need to be provided that this favourable treatment is only available if (a) the shares are in the ultimate group holding company and not in a company under the control of another body corporate; and (b) if the company has more than one class of ordinary shares in issue, the shares held by the trust are of the largest class in issue and do not have any rights or restrictions which are less favourable to the holder than those attaching to any other class of share.

It is suggested that, at the very least, Extra-Statutory Concession B18 should be enacted so as to allow non-UK trusts in receipt of UK dividend income which is distributed to UK employees, to reduce their liability to UK tax by reference to PAYE income tax paid, in much the same way that UK trusts are presently able to do under s496B Income Tax Act 2007. Under existing practice, a UK beneficiary of an offshore trust may, under ESC B18, make a claim to secure a credit for tax paid by the offshore trustee, but this is simply not practicable in many cases.

Tax-favoured plans (SIPs, SAYE, CSOP and EMI)
8. A company under the control of an employees’ trust with a single corporate trustee cannot (unless, exceptionally it is an “employee-ownership trust” of the type mentioned in s326H et seq TCGA 1992) make awards or grant options under such tax-favoured plans (because, although the company is not a 51% subsidiary of another body corporate – the trustee – , it will still be under the control of that other body corporate). By contrast, if the trustees were individuals or two or more unconnected trustee companies, the company could do so (if all other requirements are satisfied). It cannot have been intended, as a matter of policy, that the ability to take advantage of such tax-favoured schemes would depend upon the identity of the trustee(s).

It is therefore suggested that a company which is (i) under the control of a single corporate trustee (which, in its capacity as trustee, is not itself a 51% subsidiary) of an employees’ trust, and (ii) not under the control of any other person or persons, should be treated as ‘independent’ for these purposes so as to allow access to such tax-favoured schemes.

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March 2019

The government has listened: further changes to Entrepreneurs’ Relief from CGT are announced

Following representations by a number of professional bodies, the government has (on 21^st December 2018) tabled amendments to the Finance (No.3) Bill currently before Parliament so as to address many of the concerns raised that the changes proposed to be enacted following the 2018 Budget went far beyond what was required to achieve the policy intent and would have had the effect of denying the relief in those cases in which the company has more than one class of share in issue and/or the individual had no entitlement to dividends on the class of shares held.

The further measures tabled on 21 December 2018 include changes to paragraph 2 of Schedule 15 of the Finance Bill, which contains the changes to the definition of ‘personal company’ for ER purposes. These amendments add a test based on the shareholder’s entitlement to at least 5% of the proceeds in the event of a sale of the whole of the ordinary share capital in the company. This test can be used instead of those based on having an entitlement to at least 5% of both (i) the profits available for distribution and (ii) assets on a winding up. Those tests remain “to provide certainty to those with straightforward company structures”, but the new alternative test will help those who, for commercial reasons, are not able to meet the original tests. It does not rely on the definitions in the Corporation Tax Act 2010.

This provides welcome relief to many shareholders in companies with standard form articles which, for example, do not give a clear entitlement to a pro rata amount of any dividends declared.

Other changes make clear that the new alternative test is to be applied as at the last day of the period throughout which the company is required to have been the individual’s “personal company” (i.e. typically, on a sale of the company, at the time of that disposal). In determining if a company is an individual’s “personal company” by reason of the individual satisfying the new alternative test, it is to be assumed that the company is sold for its market value and that, having regard to all the circumstances, the individual is then beneficially entitled to that to which it would be reasonable to expect the person to be beneficially entitled. For this purpose, any tax avoidance arrangements are to be ignored.

January 2019

The Labour Party has proposed that all companies with more than 250 employees should, over a 10-year period, put up to 10% of their share capital into an employees’ trust. Of the dividends paid on such shares, employees would benefit from tax-free distributions of up to £500 per year, with the balance going to the government by way of a hidden form of advance corporation tax. This idea has met with derision from many companies and advisers – and rightly so.

Yet hidden within that proposal lies the seed of a perfectly good idea which might be of real attraction to many companies of whatever size.

A more balanced proposal?

I refer to the concept – first put forward  in the context of ‘employee-ownership trusts’ (see earlier posts) – that dividends on collectively-held shares in a company could be paid out to qualifying employees, on an ‘all-employee/similar terms’ basis, and that, provided such dividend income of the trust was so distributed to employees within a period of, say, 3 months of receipt:

• it would be exempted from tax in the hands of the trustees; and
• fall to be taxed as dividend, not earned, income in the hands of the employees.

Such an arrangement would be voluntary and, to an extent, ‘self-policing’ in the sense that, if there were no profits, there could be no dividends. Likewise, to the extent that all shareholders are paid dividends, so too would the employees – without individual employees needing to buy, or pay tax on the acquisition of, an actual holding of shares. The £2,000 dividend tax exemption would mean that most employees would not pay tax, and if, exceptionally, the individual distributions exceed that sum, it is surely fair and reasonable that tax (but not NICs) is paid on the amount of the excess at the employee’s marginal rate.

The shares in question would need to be of the same class as that held by the majority or controlling shareholders or, at least, have rights to receive payment of any dividends which are no less favourable than those attaching to any other class of share in issue.

To qualify for such favourable tax treatment there might be a threshold percentage level of shareholding which must be so held collectively – but this could equally be left to the determination of existing shareholders. Such a collective holding – through a trust – would also afford the opportunity for the votes attaching to such holding of shares to be cast by the trustees in a manner which they determine to be “in the best interests of employees”, and for the company to establish a corporate governance structure for the selection and appointment of trustees. That said, perhaps the principal objective of the collective ownership of shares would be best served by allowing any voting rights on such shares to be restricted or suspended.

Provision would be needed to address the question of how the proceeds of sale of the collective holding should be applied if the company were sold. This is a conundrum facing The John Lewis Partnership and other such ‘employee-owned companies’ (being not in fact ‘owned’ by individual employees): who ultimately derives benefit from the growth in capital value of such shares? It would surely be unfair for only those in employment at that time to derive such growth. If the idea is merely to encourage dividend distributions to employees, the shares so held could perhaps be redeemable at par, or for a nominal sum, in the event of a sale of the company, so that capital value is retained by other shareholders.

This is merely the seed of an idea. It will be interesting to see if the Conservative government might germinate it into a fully-developed structure for enabling employees (as opposed to the government) to share in annual profit and thereby afford incentive to work for the success of all shareholders.

30 September 2018

Given the forthcoming “outstanding loan charge” to income tax under the Disguised Remuneration rules, trustees of all forms of employee trusts should, by now, have taken steps to identify any and all loans, quasi-loans, and other forms of credit extended to employees, or to any person nominated by an employee (past or present) or any person linked with an employee (“a relevant person”) outstanding made at any time after 5 April 1999 and outstanding at any time on or after 17 March 2016.

The one-off, and penal, charge to income tax and NICs on “outstanding loans” will have effect on 5 April 2019 (or possibly later in the case of certain fixed-term loans). The scope of the charge is broader than many have assumed. In some cases, for example, it could apply notwithstanding that the indebtedness has been repaid, or the loan written-off, before 5 April 2019 but since 17 March 2016.

Penalties for failure to provide information to HMRC

If a loan or quasi-loan has been made to a relevant person on or after 6 April 1999 and any amount is, or is deemed to be, outstanding at any time between 17 March 2016 and 5 April 2019, the employee and the lender or creditor are each obliged to provide to the employer, within 10 days after the loan charge date, all the information necessary for the employer to comply with its PAYE obligations. If, having taken reasonable steps, the employee and lender have failed to contact the employer to provide the information, each is responsible for notifying HMRC of that fact in the form specified by HMRC (para 36, Sched 11). There are penalties for a failure on the part of trustees to comply with this obligation.

Avoiding the ‘outstanding loan charge’ by settlement

Of course, the outstanding loan charge will not arise if settlement of all previous tax liabilities (including inheritance tax charges, if applicable) have been agreed with HMRC, and the tax has been paid in full pursuant to HMRC’s settlement arrangements ( as to which, see https://www.gov.uk/government/publications/hmrc-issue-briefing-disguised-remuneration-charge-on-loans/hmrc-issue-briefing-disguised-remuneration-charge-on-loans ), but it is apparent that not all employers who made use of ‘disguised remuneration’ arrangements, or the employees concerned, have yet registered their interest in settlement with HMRC. There is a deadline, of 30^th September 2018, for providing all information to HMRC if settlement is to be reached before the penal charge arises on 5 April 2019.

HMRC are willing to agree 5-year payment terms for those employees with expected annual taxable income of less than £50,000, and flexible payment arrangements for those who are in genuine financial difficulty.

As part of the settlement, consideration needs to be given to how an outstanding loan is to be released or written-off and the employee put in the economic position he expects to be in once all taxes have been paid on what he or she will then regard as ‘their money’. Trustees need to consider both their obligations as trustees needing to comply with the terms of the trust deed (etc.), and the interests of the beneficiaries in winding-up the arrangements in a cost-effective manner.

There will also need to be a focus upon the terms of the trust deed (etc.) insofar as they might provide for the cost of NICs to be borne out of the trust fund, as this can reduce the costs of a settlement.

Exemptions from the ‘outstanding loan charge’

There are limited exclusions from the outstanding loan charge although none of these applies if there is a connection with tax avoidance. They relate to:

(a) certain loans made on ordinary commercial terms if similar loans were made available to members of the public at large;

(b) if an employer has made an employment-related loan below the £10,000 threshold (in s 180 ITEPA), the employee’s employment has been transferred and the employer would otherwise be treated as having made a quasi-loan by acquiring a right to repayment of the outstanding loan;

(c) subject to conditions, loans by a bank (or similar) to its employees as part of a package of benefit generally available to its employees;

(d) subject to conditions, a loan by an authorised lender made to an employee under an employee car purchase scheme;

(e) certain loans made before 9 December 2010 to enable the acquisition, within a year, of unlisted shares in the employer company or another company in the same 75% group, although an outstanding loan charge may still arise if the loan remains outstanding 12 months after the shares cease to be held by the employee.

Regulations* come into effect today, 11^th July 2018, which give effect to a government commitment to add the tax reliefs and exemptions for which EMI share options qualify to the list of tax advantages in relation to which HMRC is authorised, by s 180(2) Finance Act 2016, to collect and publish information about EU State Aid received by beneficiaries in accordance with existing EU obligations. The commitment was made by HM Treasury as part of the process for securing a renewal of EU state aid approval on 15^th May 2018 – at least until Brexit (see earlier post).

The EU’s commitment to publish information on companies which receive State Aid relates only to State Aid in excess of €500,000

The commitment is to publish information on companies that receive aid in excess of €500,000 and details of this, and of the information expected to be provided is to be found here:

https://webgate.ec.europa.eu/competition/transparency/public/search/home?lang=en

The information to be published by the EU includes, for example, the name of the business, its region and trade sector.

Neither s180 FA 2016 or the Regulations refer to a threshold limit of any amount, but it is understood that HMRC would not seek to exercise its powers to require disclosure of information on state aid insofar as there is no corresponding obligation to the EU to do so.  The amount of the state aid associated with EMI options would appear to be, broadly, the difference, as at the time of grant, between the value of an EMI option, and the value of an ‘unapproved’ option which would be expected to deliver a similar quantum of benefit net of tax. This is clearly less than the amount of the cost to HM Treasury of the tax saving to the individual, which is not itself a form of proscribed state aid. It is understood that HMRC is developing modelling tools for quantifying the amount of state aid associated with the grant of EMI share options. At present, it would appear that only a small number of companies would be beneficiaries of state aid in excess of the EU’s €500,000 threshold. For the vast majority of companies whose employees are granted EMI options this additional obligation to disclose information about the company should therefore be of no concern.

At the time of posting, we are awaiting an HMRC Bulletin giving further information as to how HMRC intends to give practical effect to the government’s transparency obligation.

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*The Enterprise Management Incentives Exemptions and Reliefs (Amendment of Tax Advantages in Schedule 24 to the Finance Act 2016) Regulations, SI 2018/737

On Tuesday 15th May, it was announced by the EU that a renewal of State Aid approval of EMI share options had been granted for a period of 5 years or until, if earlier, the time when the UK leaves the EU.

It is understood that the renewal is, in effect, backdated to 6th April 2018, when the earlier approval lapsed (see preceding post).

It remains unclear what will happen when the UK leaves the EU. The UK’s State Aid obligations will continue, and so it is for negotiation between the UK and EU as to what then happens in relation to EMI share options.

For the time being, at least, it is back to ‘business as usual’ in relation to EMI options.