UK: National Insurance Contributions, Capital Gains Tax Relief, Corporation Tax Deductions and Enterprise Management Incentives

Wider employee share ownership continues to be a major aim of the UK Government. Recent legislation and new proposals make employee share ownership even more attractive and will continue to promote this aim.

Since 6 April 1999 National Insurance Contributions (NICs) have been payable, both by employees and employers, on the gains arising where unapproved share options are exercised, and the shares acquired are "readily convertible assets" (in essence, the shares can be sold on a recognised investment exchange, or trading arrangements exist or are likely to come into existence to enable those shares to be sold).

The UK Government recently recognised that the unpredictability of the liability on companies, in respect of unapproved share option gains, is of great concern. Its response was the introduction, in July 2000, of legislation to allow employees to bear the employer’s NIC when they exercise their share options. This can be done by agreement (in which case the NIC liability remains that of the employer with a right of recovery from the employee) or by formal election (in which case the NIC liability shifts from the employer to the employee).

As an alternative, or in addition, to passing on their NIC charge, companies also look into the possibility of hedging their liability by funding an employee benefit trust to acquire shares which are later sold with the proceeds used to meet the NIC liability.

In the last Parliament the UK Government reformed the capital gains tax (CGT) regime to create incentives for investment aimed at generating sustained growth. The Finance Acts 2000 and 2001 introduced:

• a four year taper that reduces the effective rate of CGT on business assets for a higher rate tax payer from 40 per cent to 10 per cent; and
• automatic access to the business assets taper for almost all shares held by employees.

For disposals from April 2002, the Government proposes to improve the CGT business assets taper even more so that the effective rate of tax for a higher rate taxpayer is reduced to 20 per cent after only one year and 10 per cent after only two years.

Under present arrangements, businesses are not always able to deduct the cost of share options against their corporation tax liabilities. Arrangements can be put in place in the UK to obtain a corporation tax deduction for the "opportunity cost" of granting options i.e. the difference between the exercise price and the market value of the shares subject to options on the date of exercise. To encourage more businesses to consider the awarding of share options to their employees, the Government has announced that it will consider whether a corporation tax deduction should be made available as a matter of course and how access to it could be streamlined.

Enterprise Management Incentives (EMIs) are designed to help small high-risk companies grant tax- efficient share options in order to attract the high quality management they need to fulfil their growth potential. Individuals may be granted options over shares worth up to £100,000 (at grant), up to a total value of £3 million per company. The shares acquired are then taxed as capital gains at the time of sale rather than upon exercise of the option. In practice this means most EMI optionholders will be taxed at an effective capital gains tax rate of 10 per cent on the gain. The EMI scheme has proved attractive to business; by March 2001 over 1,000 companies have awarded EMI options.

The Government believes that it is now right to build on the success of EMI and offer its advantages to more businesses. This may be of particular help to particular small dynamic manufacturing enterprises which are more likely to have assets in excess of the current £15 million gross assets limit. The UK Government has therefore proposed to raise this limit to £30m.

"© Herbert Smith 2002

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