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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 exit events: overview and conditions

Section 554K(1) and (2) ITEPA 2003

Conditions
The Section 554K exclusions: introduction
Section 554K exclusion for actual awards
Section 554K exclusion for expected awards
Connection with tax avoidance arrangement
Section 554K: later events

The trustee of an employee share scheme may earmark shares in order to meet its commitments. 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 Section554K are met.

Section 554K is an exclusion for employee share schemes which have specified exit events.

This page explains the Section 554K conditions and sets out the Section 554K exclusions in detail.

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Conditions

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

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

Section 554K(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’ which are not units in a collective investment scheme, or
  • a sum of money the amount of which is to be determined by reference to the market value of any such relevant shares at the time the sum is paid.

On ‘relevant shares’, see EIM45480. But note that, although ‘relevant shares’ in Sections554J to 554M can include units in a collective investment scheme, in Section554K(1)(a) it cannot.

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

Section 554K(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 554K(1)(c)

There are two possibilities.

  • The first possibility is that the relevant shares would be shares (including stock) in:

    • a company the business of which consists wholly or mainly in the carrying on of a trade, or
    • a company which controls such a company.
  • The second possibility is that the relevant shares would be instruments which meet two conditions.

First, they are debt instruments to be precise, securities for the purposes of Part 7 Chapters 1 to 5 ITEPA 2003 within section 420(1)(b) ITEPA 2003 (see ERSM20140).

Second, they are issued by:

* a company the business of which consists wholly or mainly in the carrying on of a trade, or
* a company which controls such a company.

Section 554K(1)(d)

The award would be on terms (‘the deferred award terms’) the main purpose of which is to ensure that:

  • the relevant shares are not received, or
  • the sum of money is not paid,
  • unless:
  • a specified exit event occurs, or
  • an exit event within a specified description occurs.

On ‘exit events’, see EIM45465.

Section 554K(1)(e)

As at the award date, there would be a reasonable chance that:

  • the specified exit event will occur, or
  • an exit event within a specified description will occur.

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The Section 554K exclusions: introduction

If the arrangement meets the conditions in Section 554K(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 554K exclusions, it does not give rise to Part 7A income at that stage.

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Section 554K exclusion for actual awards

To come within the Section 554K exclusion for actual awards, a relevant step must meet the seven conditions in Section 554K(2). These conditions are bulleted below.

  • The relevant step is within Section 554B.
  • But for Section 554K, 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 554K(1)(a).
  • Second, this award meets the requirements of Section 554K(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 554K exclusion for expected awards

To come within the Section 554K exclusion for expected awards, a relevant step must meet the seven conditions in Section 554K(2). These conditions are bulleted below.

  • The relevant step is within Section 554B.
  • But for Section 554K, 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 554K(1)(a).
  • Second, if this award is made, it will meet the requirements of Section 554K(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 bulleted above.

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

  • to come within Section554K, 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 554K: later events

If a Section 554K 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 EIM45390.

A fall-back charge may apply if a relevant step comes within the Section 554K exclusion for expected awards but the award is delayed. See EIM45395.

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. See EIM45400.

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