UK: Employers With Share Option Schemes Take Note…

Last Updated: 24 July 2013
Article by Richard Cook and James Ross

A recent decision of the United Kingdom's First Tier (Tax) Tribunal has provided a timely reminder of the importance for employers of notifying their employees of the requirement to promptly reimburse the employer for income tax payments made on his or her behalf following the exercise of an option under a share option scheme.

The Background

Income tax is due on a chargeable event in relation to a share option.  An example of such an event is when an employee exercises his or her share options, i.e. the date on which he or she acquires the beneficial ownership of the shares.

The employer is obliged to account to Her Majesty's Revenue and Customs ("HMRC"), via the usual pay as you earn ("PAYE") route, for the income tax and national insurance contributions ("NICs") due at that date.  The employee must reimburse the employer in full within 90 days for the income tax accounted to HMRC, otherwise he or she becomes liable for a penal tax charge payable to HMRC.  Essentially, the payments "withheld" by the employer become treated as an income payment in themselves, and the employee has to pay the "tax on the tax".

The Decision

In Benedict Manning v HMRC, Mr Manning notified his employer of the exercise of his option to buy shares with a market value of over £100,000 at a price of just over £7,000. His employer paid tax and NICs on his behalf.  Under the share option scheme, Mr Manning was required to repay his employer upon receipt of a statement setting out how much he owed.  His employer failed to send him this statement for several months.

When he finally did receive the statement, he repaid his employer in full immediately, but more than 90 days after the initial payment was made to HMRC.

During a PAYE audit, HMRC became aware that Mr Manning had repaid his employer outside the statutory time limit.  They brought proceedings to enforce the penal tax provisions against Mr Manning.  By this point his shares had dropped in value to less than he had paid for them, leaving him significantly out of pocket.

The option agreement provided that, as a condition of the exercise of the option, the employee was required to pay the amount of any PAYE liability to the company within 30 days of exercise or by the date the company had to account for the tax, whichever was earlier.  As this had not happened, the Tribunal concluded that Mr Manning did not acquire the shares until he in fact made payment to the company, meaning he was not 90 days late in reimbursing the company and the "gross up" charge did not apply.

What Does This Mean For Employers?

On its face, the decision seems to vindicate the carefully drafted option agreement, but whilst such provisions can be helpful, no employer will want to find itself having to rely on them.  The Tribunal was clearly sympathetic with Mr Manning's plight and, as a result, reached a decision that, in our view, is highly susceptible to being reversed on appeal.

As such, employers should ensure they have a good handle on the procedural requirements of their own share option schemes, which will usually have been drafted in accordance with relevant legislation.  At a minimum they should notify their employees of the requirement to reimburse within the 90 day window. 

Although the liability does not fall on employers, a hefty tax bill, which could have been avoided by a simple notification to the employee of his or her liability and the potential consequences of failing to make it good, is likely to have a damaging effect on morale and could potentially be a breach of the implied term of trust and confidence.

This is particularly so where an employer's share option scheme is run out of a parent company based in another jurisdiction, where the technicalities of UK tax legislation may not be fully appreciated.

The good news for employees and employers alike is that the UK Government has recently announced that it intends to consult on repealing the 90 day time limit for reimbursement and replacing it with the date of 6 July following the end of the relevant tax year.  This should ease the administrative and cash flow disadvantages of the current system. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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