View the related Tax Guidance about Convertible securities
Convertible securities
Convertible securitiesOverviewShares or securities may have certain rights to convert into other types of shares or securities on specific events or may be subject to certain conditions. Where the securities are also employment related securities (ERS), they may be considered to be ‘convertible securities’ under ITEPA 2003, ss 435–444 (Pt 7, Ch 3). See the Employment related securities overview note for the definition of ERS.On conversion, the value of the shares or securities may increase so that the holder makes a notional gain or can sell the new securities for a real gain.Where the rules on convertible securities apply, income tax and potentially NIC are charged on a gain (or notional gain) where certain chargeable events occur. It is important to note that convertible securities might also be restricted securities (see the Restricted securities guidance note). If the securities also fall within the scope of the restricted securities rules, treating the securities as restricted securities and using a section 431 election may minimise the overall liability.What are convertible securities?Convertible securities are shares, securities or similar rights including debentures, bonds or loan notes, where:•the holder can convert the securities into other securities either automatically or if conditions are met in future, eg if E class non-voting shares convert into A class voting shares on a takeover•an entitlement to convert arises later under the terms of an agreement, arrangement or condition which existed at the time the securities were acquired, eg an employee acquires non-voting shares on the understanding
Employment-related securities ― PAYE
Employment-related securities ― PAYEIntroductionAwards of securities, exercise (or vesting) of securities options and certain other events relating to employment related securities (ERS) may be liable to income tax as earnings under ITEPA 2003 s 62, or the special ERS rules under ITEPA 2003 ss 417 – 554 (Part 7).The tax charges may be personal tax charges for the employee via self-assessment, or employers may be obliged to withhold income tax and NIC under PAYE.This note aims to set out which ERS related tax charges, and in what circumstances, employers must operate PAYE and NIC, and the practical implications of doing so.Share awardsAn outright award of ERS represents ‘money’s worth’ and is taxable under ITEPA 2003, s 62. The taxable amount is the market value of the securities less any payment made by the employee. Market value is de-fined at TCGA 1992 ss 272 - 273The ‘money’s worth’ taxable amount may be a personal tax liability of the employee, payable via their self-assessment tax return, or there may be a liability to withhold income tax and NIC under PAYE for the employer. This depends on whether the securities are considered to be ‘readily convertible assets’ (RCAs). Where the ERS are RCAs, income tax and NIC will be due via PAYE. Where the ERS are not RCAs, income tax will be due via the employee’s self-assessment tax return with no NIC due.What are Readily Convertible Assets?RCAs are defined in ITEPA 2003 s 702. The intention of the category of RCAs is
Employment-related securities ― overview
Employment-related securities ― overviewIntroductionShares, or other forms of securities, awarded to employees may be taxed as:•earnings, or•under the special employment-related securities (ERS) rules, which seek to modify the tax position in cases where the tax result that would flow from the particular circumstance does not reflect the full economic value received, or where the Government has determined that it wants a different tax burden or timing to apply.What are securities?The definition of ‘security’ includes stocks and shares of any description but is very wide and also includes items which one would not normally describe as a security, such as insurance contracts and contracts for differences. The definition excludes certain items such as cheques and bank statements (which hardly any-one would think of as such) but, perhaps surprisingly, excludes security options (unless used as part of a tax avoidance arrangement). However securities options are subject to their own specific rules. ITEPA 2003 ss471 – 484 (Chapter 5)The significance of ‘employment related securities’It has long been established by case law that where an employee acquires shares in their employing company and pays less than market value for those shares, the discount is taxable as earnings (as defined in ITEPA 2003, s 62). Charge on acquisitionThe charge to tax on employment income in ITEPA 2003, s 6 relates to:•general earnings•specific employment incomeIn outline, ‘general earnings’ are earnings within s 62 and amounts ‘treated as’ earnings, which includes benefits in kind within the benefits code, while ‘specific employment income’
Corporate debt ― overview
Corporate debt ― overviewThis guidance note provides an introduction to the provisions governing the taxation of debt for UK companies and also provides links to more detailed guidance notes dealing with those provisions.The taxation of corporate debt in the UK is complex. There are several different sets of rules governing the amount and timing of tax deductions available for interest and other amounts relating to corporate debt. These include:•the loan relationships regime•the corporate interest restriction (CIR) rules•transfer pricing and thin capitalisation requirements•a range of associated anti-avoidance measures ― it should be noted that there are regime anti-avoidance rules (RAARs) in CTA 2009, ss 455B–455D and related sections for loan relationships and in TIOPA 2010, s 461 applicable to the CIRIt should also be remembered that payments of interest by a UK company on all liabilities capable of remaining outstanding for more than one year are subject to withholding tax, unless they are expressly exempt or qualify for relief.Loan relationshipsIn most instances, a company’s financing costs and income are taxed or relieved under the loan relationships regime. Relief is only available where the cost attaches to the company’s own loan relationships or a balance which is deemed to be a loan relationship for tax purposes. See the What is a loan relationship? guidance note.A loan relationship exists where a company stands in the position of debtor or creditor in respect of a money debt that arises from a transaction for the lending of money. Although, it
Preparing for an employment-related securities due diligence exercise
Preparing for an employment-related securities due diligence exercise IntroductionDue diligence (DD) exercises looking at employment-related securities (ERS) and share schemes take place in a number of circumstances but broadly all with the same aim ― to look at risk areas around ERS and share schemes where there could be liabilities, penalties or other risks for the company. Where possible, the DD report will quantify those risks. It is worth noting that tax liabilities which do not rest with the company are not usually within the scope of a DD report eg income tax charges which fall solely on an employee or director would not be within scope, but income tax due via PAYE would be.An ERS DD could be expected when any mergers and acquisitions (M&A) activity is due to take place. This includes, but is not limited to:•when marketing the company for sale•a bank or other lender considers making a loan to the company•a person or organisation considers investing in a business•when preparing to list on a stock exchange via initial public offering (IPO)It is unusual for an ERS DD to be a stand-alone exercise unless it has already been identified as a high-risk area for the company; it is more likely to occur as part of a broader tax DD or as part of a full financial, tax and legal DD project. This note aims to explain what information a company is likely to be asked to provide, but please note that the
Geared growth arrangements ― where are we now?
Geared growth arrangements ― where are we now?There are a number of equity schemes which companies offer to their staff to drive performance and to reward loyalty which are not government-supported. These are known by a variety of names, including: growth, flowering or freezer schemes and joint ownership arrangements. In the main they are used to deliver equity in a way which falls within the capital gains tax (CGT) regime rather than participants being subject to higher rates of income tax and NIC.Very often companies will look to implement these types of scheme where traditional tax-advantaged employee share plans such as Enterprise Management Incentive schemes (EMI) ( see the Why use an enterprise management incentive (EMI) scheme? guidance note) or Company Share Option Schemes (CSOP) (see the Why use a company share option plan (CSOP)? guidance note guidance note) are not available. For example companies may be too large to offer EMI or have balance sheet assets in excess of the relevant limit. With CSOP, whilst there is no longer any prior approvals process with HMRC, the need for companies to meet various tests in relation to both their share capital and the design of the scheme, coupled with the relatively modest limit in the value of shares under CSOP option, may act as a deterrent.These alternative schemes have come under HMRC scrutiny as part of the drive to curb anti-avoidance in relation to employee reward. In June 2010 the coalition government announced that arrangements involving geared growth would
Annual reporting for non-tax advantaged share schemes
Annual reporting for non-tax advantaged share schemesAnnual returnsCompanies operating any type of share scheme or arrangement involving employment related securities (ERS) are required to make an online annual return by 6 July after the end of the tax year in which the scheme or arrangement was registered, and each tax year during the life of the scheme or arrangement. This includes where the company is making a nil return (see below).HMRC’s 6 July deadline is a strict one and failure by a company to make the relevant annual return will have serious consequences, including penalties. Late filing of ERS annual returns is commonly raised as an issue in due diligence exercises, which can delay company transactions and reorganisations.It is therefore essential that companies operating non tax-advantaged share schemes, or arrangements such as making awards of shares or other securities to employees, directors or other office holders, are familiar with and fulfil their compliance obligations. For more information on the requirement to register share schemes and arrangements, please see the Registration of non tax-advantaged share schemes guidance note.HMRC has no obligation to remind a company to make its annual returns. It is therefore important that the company is prepared to make the annual returns on time. The person responsible for making an annual return submission may find it helpful to set electronic calendar reminders in the period leading up to the deadline and build in extra time if a new scheme needs to be registered for that tax year, or
Introduction to share schemes
Introduction to share schemesIntroductionHistorically, the development and use of share schemes can be linked to companies seeking to use the rules to reward employees and directors in a way that did not, typically, attract income tax and national insurance contributions. However, as with all such schemes, the legislation has developed in order to ensure that payments by way of salary or bonus could not be simply recategorised in this way and paid out with lower (or even no) tax due.The share schemes legislation sets out a wide range of scenarios where income tax and, potentially, national insurance are due on transactions and events that involve shares and securities, particularly those where the recipients have an employment relationship with the company.However, share schemes are still a popular method of incentivising employees and there are a number of specific plans set out by tax legislation for companies to use. For commentary on why share schemes are popular methods of retaining staff, see the Why use a share scheme? guidance note.From 6 April 2014, share schemes, including share option schemes, no longer need to be approved by HMRC in advance of award of the shares or grant of the option. Instead, the company must provide notification within a certain time frame and self-certify that a scheme meets the criteria to benefit from the beneficial tax rules. Share schemes that were previously known as ‘approved’ schemes are now referred to as ‘tax-advantaged’ schemes.Given that tax-advantaged schemes confer tax benefits on the shares or
Employer consequences of share schemes
Employer consequences of share schemesThere are a number of different consequences that can arise for employers as a result of introducing and operating employee share incentive arrangements, some beneficial and some costly.There may be an opportunity to obtain corporation tax relief on payments in the form of shares. This relief might also extend to the cost of implementing and running share schemes.Companies are also obliged to account for PAYE in respect of employee share awards in certain circumstances and on certain ‘chargeable events’ in relation to employment-related shares.Finally, companies that employ individuals who benefit from share schemes must budget for any employer’s NIC liability that might arise. This represents a real cost though in some circumstances it may be passed on to the employee.This guidance note does not consider the implications of the disguised remuneration legislation since this is looked at in detail elsewhere (see the Disguised remuneration ― overview guidance note) and is only peripheral to employee share arrangements.Corporation tax reliefIn order for shares to qualify for corporation tax relief, they must meet a number of different requirements. If certain statutory reliefs in respect of the costs of employee share schemes do not apply, the company may make a case to its HMRC office that it is entitled to make a deduction from corporation tax under general principles, eg where the expenditure was necessary to benefit the business.The company’s businessIn order to qualify for corporation tax relief in respect of employee shares awards the company must, as a
Derivative contracts
Derivative contractsA derivative contract is a financial instrument, or security, whose price is dependent on, or derived from, one or more underlying assets or indices. It is simply a contract between two or more parties whose value is determined by fluctuations in the underlying asset or index.The taxation of derivative contracts tends to make tax practitioners nervous unless they are experienced in the financial markets. However, the tax rules governing the basic derivative contracts used in day-to-day treasury transactions (eg forward currency contracts and interest rate swaps) are relatively straightforward. Many companies will have these types of basic derivative contracts without realising they fall within the derivatives rules, so it is worth discussing specific types of arrangement rather than derivatives generally when initially advising on derivatives.This guidance note steers readers through the rules and provides an overview of the main provisions and their practical application. It includes comments on the main definitions, the basis of taxation and the core anti-avoidance rules.The rules governing the taxation of derivative contracts generally follow the same principles as the loan relationship regime. It is an accounts based income regime, ie unless there is an express provision to the contrary, the amounts recognised in the statutory accounts of the company are taxed as income rather than capital. The starting point for tax purposes for a derivative contract is to bring into account the credits or debits recognised in the P&L for the period in question in accordance with generally accepted accounting practice (GAAP). This
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