Against a background of shares having been used by employers to reduce income tax (and NICs) on earnings, a special set of income tax charges now apply to shares acquired in connection with employment. The ability to argue that the employee acquires his shares purely in the capacity of investor has been severely curtailed. The effect is that the higher income tax rates may apply instead of capital gains tax when the shares are sold.
Because the rules catch not just shares but also other forms of "paper" issued by companies (e.g. debentures, bonds, warrants), the legislation uses the term "employment-related securities" (ERS).
Not only is "securities" widely defined but so are the circumstances in which they are regarded as "employment-related". First, a security is employment-related if it was acquired (as a matter of fact) because of the prospective, current or former employment of that person or some other person. Secondly, a security is deemed to be employment-related if it is made available by the employer or somebody connected with the employer regardless of whether it was acquired because of employment as a matter of fact. There is an exception to this deeming if the employer is an individual and the shares or securities are provided in the normal course of family or personal relationships.
Tax charge on acquisition
Even without the special set of income tax charges for ERS, an income charge would arise on general principles if the employer gifts shares or indeed any asset to their employer. The same applies if the employer sells the shares to the employee for a consideration that is less than their market value. This is a point that must always be considered when an employee acquires shares because it can give rise to an immediate tax charge.
In practice, much of the historic tax planning relied not on gifting shares or selling them at an undervalue but using artificial restrictions to reduce the market value of the shares on acquisition. The restrictions would subsequently be released and so allowing value to flow back into the shares. Accordingly, the first set of special tax provisions applies to ERS whose value has been reduced because of restrictions imposed on them. Tax is charged on a proportion of any increase in value resulting from the lifting of the restrictions or when they are sold. These provisions are not though confined to tax avoidance arrangements. For this reason, they have to be considered on a regular basis because restricted shares are heavily used in the venture capital and private equity sectors for nontax reasons. Usefully, it is possible for the employer and employee to elect out of these provisions altogether. However, they must then accept that any restrictions that reduce the value of the shares on acquisition are disregarded. The result is that any tax charge on acquiring the shares is calculated as the difference between this notional "unrestricted" market value and what (if anything) the employee pays for them.
There are further sets of special tax provisions that apply to ERS:
i) that are convertible into other securities;
ii) whose market value has been artificially depressed on acquisition;
iii) whose market value is artificially enhanced after acquisition;
iv) which are sold for more than their market value; or
v) if a person receives a benefit in connection with the ERS.
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.