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HMRC internal manual

Employment Income Manual

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Employment income provided through third parties: exclusions: earmarking for employee share schemes: specified vesting date: overview and conditions

Section 554J(1) to (3) ITEPA 2003

Conditions
Possibility of partial revocation
The Section 554J exclusions: introduction
Section 554J exclusion for actual awards
Section 554J exclusion for expected awards
Connection with tax avoidance arrangement
Section 554J: later events

The trustee of an employee share scheme may earmark shares in order to meet its commitments under the scheme. This will be a step within Section 554B which, if the other statutory conditions are met, will take the arrangement through the Section 554A gateway.

But this step will not give rise to Part 7A income if all the conditions of Section554J are met.

Section 554J is an exclusion for employee share schemes which have a specified vesting date.

This page explains the Section 554J conditions and sets out the Section 554J exclusions in detail. For illustrative examples, see EIM45360.

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Conditions

Section 554J can only apply if B is a company.

An employee share scheme needs to meet the five conditions in Section 554J(1)(a) to (e) if it is to come within Section 554J.

Section 554J(1)(a)

There is an arrangement (‘B’s employee share scheme’) under which, in respect of A’s employment with B, an award may be made to A of:

  • ‘relevant shares’, or
  • a sum of money the amount of which is to be determined by reference to the market value of any relevant shares at the time the sum is to be paid.

On ‘relevant shares’, see EIM45480.

It does not matter whether the award may be made by B or by some other person.

Section 554J(1)(b)

The main purpose of the award would not be the provision of relevant benefits.

‘Relevant benefits’ has the same meaning as in Part 6 Chapter 2 ITEPA 2003 (EFRBS), except that, here, ‘relevant benefits’ can include benefits charged to tax under Part 9 ITEPA 2003 (pension income). See EIM15021.

Section 554J(1)(c)

The award would be on terms (‘the deferred award terms’) which have three features in particular.

  • First, the main purpose of the deferred award terms is to defer (1) the receipt of the shares by A or (2) the payment of the sum of money to A.
  • Second, this receipt or payment is deferred to a specified date (‘the vesting date’) which is after the date (‘the award date’) on which the award is made.
  • Third, the deferred award terms provide that the award is revoked if specified conditions are not met on or before the vesting date.

On ‘specified date’, see EIM45485.

When studying the terms of an award, you need to consider what is being deferred.

If the main purpose of the terms is to defer the receipt of the shares by A, and the other statutory conditions are met, then the award will satisfy Section 554J(1)(c).

If, however, shares are awarded to A at the outset, but restrictions are imposed on the shares whose main purpose is to defer A’s remuneration, then the award will not satisfy Section554J(1)(c). Such shares will be restricted securities see ERSM30000 onwards.

Section 554J(1)(d)

The vesting date would not be more than ten years after the award date.

‘The vesting date’ is an expressly defined term for Section 554J purposes. It will not necessarily correspond with ‘the vesting date’ as defined in the legal documentation for the share scheme under review.

Section 554J(1)(e)

As at the award date, there would be a reasonable chance that the award will be revoked because not all the specified conditions will be met on or before the vesting date.

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Possibility of partial revocation

To come within Section 554J(1), an award must pass the ‘reasonable chance’ test in Section554J(1)(e).

Under Section 554J(2), the terms of the award may also (but do not have to) provide that the award of the deferred remuneration is partly revoked if certain conditions are not met on or before the vesting date.

Therefore, if:

  • an award of deferred remuneration passes the seven tests set out above, and
  • the award is made on terms which provide that the award will be lost in part if the specified conditions are not met completely,

then the award will come within Section 554J(1).

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The Section 554J exclusions: introduction

If the arrangement meets the conditions in Section 554J(1), two exclusions are available. They are very similar. One relates to actual awards. The other relates to expected awards.

If a relevant step comes within either of the Section 554J exclusions, it does not give rise to Part 7A income at that stage.

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Section 554J exclusion for actual awards

To come within the Section 554J exclusion for actual awards, a relevant step must meet the seven conditions in Section 554J(3). These conditions are bulleted below.

  • The relevant step is within Section 554B.
  • But for Section 554J, the relevant step would give rise to Part 7A income.
  • The subject of the relevant step is relevant shares (‘the earmarked shares’) which are earmarked (or otherwise start being held) solely with a view to the meeting of an award which meets two conditions.
  • First, this award is made to A as mentioned in Section 554J(1)(a).
  • Second, this award meets the requirements of Section 554J(1)(b) to (e).

On ‘solely’, see EIM45320.

  • E ≤ X, where

    • ‘E’ is the number of any relevant shares of any type which are earmarked shares, and
    • ‘X’ is the maximum number of relevant shares of that type which one might reasonably expect to be needed for meeting the award.

On ‘the maximum number one might reasonably expect’, see EIM45470.

  • There is no connection (direct or indirect) between the relevant step and a tax avoidance arrangement. See EIM45855.

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Section 554J exclusion for expected awards

To come within the Section 554J exclusion for expected awards, a relevant step must meet the seven conditions in Section 554J(3). These conditions are bulleted below.

  • The relevant step is within Section 554B.
  • But for Section 554J, the relevant step would give rise to Part 7A income.
  • The subject of the relevant step is relevant shares (‘the earmarked shares’) which are earmarked (or otherwise start being held) solely with a view to the meeting of an award which meets two conditions.
  • First, this award is expected to be made to A as mentioned in Section 554J(1)(a).
  • Second, if this award is made, it will meet the requirements of Section 554J(1)(b) to (e).
  • E ≤ X, where

    • ‘E’ is the number of any relevant shares of any type which are earmarked shares, and
    • ‘X’ is the maximum number of relevant shares of that type which one might reasonably expect to be needed for meeting the expected award.

On ‘the maximum number one might reasonably expect’, see EIM45470.

  • There is no connection (direct or indirect) between the relevant step and a tax avoidance arrangement. See EIM45855.

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Connection with tax avoidance arrangement

Ordinary commercial arrangements should pass the anti-avoidance test mentioned above.

But you must examine an arrangement critically, if it purports:

  • to come within Section554J, and
  • to defer tax liability beyond the statutory time limits.

Such an arrangement may well fail the anti-avoidance test.

This is an illustrative example. The anti-avoidance test is broad. It may catch other avoidance transactions.

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Section 554J: later events

If a Section 554J exclusion prevents a relevant step from giving rise to Part 7A income, that is not the end of the story.

In special circumstances, there will be a fall-back charge on the vesting date. See EIM45365.

A fall-back charge may apply if a relevant step comes within the Section 554J exclusion for expected awards but the award is delayed. See EIM45370.

There will be a fall-back charge if, broadly speaking, shares continue to be earmarked in circumstances in which the conditions for the exclusion are no longer met. SeeEIM45375.

In practice, taxpayers are likely to arrange their affairs so that none of these fall-back charges applies.