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HMRC internal manual

Employment Income Manual

PAYE: special types of payment: employee’s requirement to make good PAYE: meaning of making good: indemnity: example

Section 222 ITEPA 2003

Share Incentive Arrangements

Where an employer has a share scheme which is set up as a genuine incentive scheme, intended to be operated (and normally operated) in compliance with tax withholding obligations, and which provides for awards of shares which will be taxed under Part 7 ITEPA 2003, it is likely that the contention that the existence of an indemnity is sufficient to satisfy the making good requirements of section 222 will succeed. There is an expectation that there will be a charge to tax as employment income and that when the charge to tax arises the amount chargeable will be subject to the operation of PAYE by the employer. Consequently, there is also an expectation that the employer will recover from the employee, either directly or indirectly, the full amount needed to meet the cost of accounting for the PAYE tax.

If the arrangements are such that by participating in the scheme the employee is committed to indemnifying the employer for any taxes which become due that may be construed as providing to the employer something of value. The indemnity agreement is likely to have a value equivalent to the due amount because the employee knows that the full amount needed to pay the PAYE tax can be recovered. The value of the indemnity agreement can be measured in financial terms since the employee has given the employer the legal right to recover the due amount in full under the terms of the agreement. That right will have been given within 90 days of the relevant date since it will have been in existence at the relevant date.  It will mean therefore that the requirements of section 222(1)(c) are not satisfied and there can be no charge to tax under section 222.

There may be exceptional occasions where the employer fails to recoup the due amount from an award to an employee. Providing that the indemnity clause is usually acted upon, such exceptional cases will not reduce the value of the indemnity agreement for the purposes of section 222.


Y Inc. is a Canadian company whose shares are traded on the Toronto Stock Exchange (and therefore are readily convertible assets). Y Inc. heads a multinational group with subsidiaries and employees in each of USA, Spain, Hong Kong and Australia. Y Inc. operates an international share option plan, administered at the head office in Canada, under which selected employees are granted options to acquire shares in Y Inc. The share option plan rules includes a tax indemnity that requires option holders to reimburse any tax liability which Y Inc. or any subsidiary of Y Inc. is required to account to any tax authority in connection with the share options granted. Y Inc. and/or its subsidiary companies have habitually required option holders, in each of the above jurisdictions, to reimburse their employer for any tax which it has been required to account to its local tax authority.

Y Inc. decides to expand its operations and sets up a subsidiary in the UK (Y Ltd), which has UK resident employees, some of whom are granted options under Y Inc.’s international share option plan.

As and when the UK employees exercise their options to acquire Y Inc. shares, Y Inc. issues the shares to the employees. As a result of the exercise of the options, each of the UK employees is subject to a tax charge under section 476 ITEPA on the amount of the option gain realised. Because the shares acquired are readily convertible assets Y Ltd is required to operate PAYE and account for NICs liability.

However, as the UK employees submitted their exercise notices directly to Y Inc.’s head office in Canada, Y Ltd was not aware that shares had been acquired. In addition, Y Inc. was unaware that the Y Ltd had an obligation to operate PAYE and so did not inform Y Ltd of the exercise of share options by its employees. Consequently, Y Ltd failed to operate PAYE and account for NICs and neither Y Inc nor Y Ltd enforced the tax indemnity.

The PAYE failure comes to light some years later as part of a routine PAYE audit and is not disputed. Y Ltd then seeks to recover the PAYE income tax from the employees concerned.

Is there a charge to tax under section 222?

Clearly, the conditions in section 222(1)(a) and (b) are satisfied. However, a section 222 tax charge does not arise in these circumstances because the requirements of section 222(1)(c) will not be satisfied. The tax indemnity in Y Inc.’s international share option plan is habitually enforced and therefore has a monetary value equal to the due amount. The PAYE failure and the associated failure to enforce the tax indemnity should not be construed as devaluing the tax indemnity. Consequently, each UK employee has made good the due amount to Y Ltd by virtue of the employer having the legal right to recover the PAYE income tax, which it should have accounted for, from the employee.