EIM45405 - Employment income provided through third parties: exclusions: earmarking for employee share option schemes: specified vesting date: overview and conditions
Section 554L(1) to (3) ITEPA 2003
Conditions
Specified conditions: possibility of partial revocation
The Section 554L exclusions: introduction
Section 554L exclusion for actual grants
Section 554L exclusion for expected grants
Connection with tax avoidance arrangement
Section 554L: later events
The trustee of an employee share option 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 Section 554L are met.
Section 554L is an exclusion for employee share schemes which have a specified vesting date.
This page explains the Section 554L conditions and sets out the Section 554L exclusions in detail. For illustrative examples, see EIM45410.
Conditions
Section 554L can only apply if B is a company.
An employee share option scheme needs to meet the five conditions in Section 554L(1)(a) to (e) if it is to come within Section 554L.
Section 554L(1)(a)
There is an arrangement (‘B’s employee share scheme’) under which, in respect of A’s employment with B, a right (‘a relevant share option’) may be granted to A:
- to acquire ‘relevant shares’, or
- to receive 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 right may be granted by B or by some other person.
Note that ‘relevant share option’ has a wide meaning. For example, it is capable of covering a long term incentive plan under which A will be awarded shares automatically at a future date if specified conditions are met.
Section 554L(1)(b)
The main purpose of the grant of the relevant share option 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 554L(1)(c)
The grant would be on terms (‘the deferred award terms’) which have two features in particular.
- First, the main purpose of the deferred award terms is to ensure that A cannot exercise the relevant share option before a specified date (‘the vesting date’) which is after the date (‘the grant date’) on which the grant is made.
- Second, the deferred award terms provide that A cannot exercise the relevant share option at all if specified conditions are not met on or before the vesting date.
On ‘specified date’, see EIM45485.
If A becomes able to exercise the relevant share option early and does so, see EIM45415 (in particular, cases 1 and 2).
Section 554L(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 554L purposes. It will not necessarily correspond with ‘the vesting date’ as defined in the legal documentation for the share option scheme under review.
Section 554L(1)(e)
As at the grant date, there would be a reasonable chance that A will not be able to exercise the relevant share option at all because not all the specified conditions will be met on or before the vesting date.
On the ‘exercise’ of options, see EIM45460.
Specified conditions: possibility of partial revocation
To come within Section 554L(1), an award must pass the ‘reasonable chance’ test set out above.
Under Section 554L(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 554L(1).
The Section 554L exclusions: introduction
If the arrangement meets the conditions in Section 554L(1), two exclusions are available. They are very similar. One relates to actual grants. The other relates to expected grants.
If a relevant step comes within either of the Section 554L exclusions, it does not give rise to Part 7A income.
Section 554L exclusion for actual grants
To come within the Section 554L exclusion for actual grants, a relevant step must meet the seven conditions in Section 554L(3). These conditions are bulleted below.
- The relevant step is within Section 554B.
- But for Section 554L, 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 providing relevant shares pursuant to a relevant share option which has been granted and whose grant meets two conditions.
- First, this grant is made to A as mentioned in Section 554L(1)(a).
- Second, this grant meets the requirements of Section 554L(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 providing shares pursuant to the grant.
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.
Section 554L exclusion for expected grants
To come within the Section 554L exclusion for expected grants, a relevant step must meet seven conditions. These conditions are bulleted below.
- The relevant step is within Section 554B.
- But for Section 554L, 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 providing relevant shares pursuant to a relevant share option which is expected to be granted and whose grant meets two conditions.
- First, this grant is expected to be made to A as mentioned in Section 554L(1)(a).
- Second, if this grant is made, it will meet the requirements of Section 554L(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 providing shares pursuant to the expected grant.
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.
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 Section 554L, 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.
Section 554L: later events
If a Section 554L 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 final exercise date. See EIM45415.
A fall-back charge may apply if a relevant step comes within the Section 554L exclusion for expected grants but the grant is delayed. See EIM45420.
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 EIM45425.
In practice, taxpayers are likely to arrange their affairs so that none of these fall-back charges applies.