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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 option schemes: specified vesting date: examples

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

Specified conditions: bad leavers
Specified conditions: gross misconduct
Specified conditions: deferred remuneration received early
Specified conditions: conditions later lifted

Here are some examples illustrating the conditions in Section 554L (earmarking for employee share option schemes: specified vesting date).

On the conditions in Section 554L generally, see EIM45405.

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Specified conditions: bad leavers

Even if the only circumstances that would result in the specified conditions failing to be met are that the employee departs from the employment as a ‘bad leaver’, this test can still be passed provided that it is realistic to suppose that the terms of the bad leaver clause could be satisfied.

But this will only apply if there is no possibility of the employee receiving the reward if the conditions for forfeiture are triggered.

Note that ‘bad leaver’ is a commercial term; for tax purposes, what matters is whether the statutory conditions are met.

Whether or not the ‘reasonable chance’ test is passed will depend on the facts of the case.

But the specified conditions must be genuine and not amount to guaranteed remuneration, just at a future date.

Where ‘bad leaver’ clauses include a provision for the remuneration committee or Board to exercise its discretion to override the rules in exceptional circumstances, the terms of grants can still be capable of meeting the condition in Section 554L(1)(e) namely, if there is a reasonable chance that the grant is revoked because the conditions for obtaining it have not been met.

In other words, grants on such terms will be capable of coming within the earmarking exclusion in Section 554L for deferred grants.

But, again, whether a grant on such terms comes within Section 554L will depend on the facts of the case. And the conditions, when looked at against any residual discretion of the remuneration committee, must be genuine.

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Specified conditions: gross misconduct

Suppose that the specified conditions would fail to be met if but only if the employee was dismissed for gross misconduct.

Gross misconduct is a single act of misconduct that is serious enough on its own to justify the employee’s immediate dismissal.

Realistically, an employer is not going to make a grant of deferred remuneration to an employee whom the employer reasonably expects to dismiss for gross misconduct before the grant vests.

The ‘reasonable chance’ test must be passed at the time when the grant is made.

Therefore, in this scenario, there is no reasonable chance that the grant will be revoked. And so the ‘reasonable chance’ test is not passed.

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Specified conditions: deferred remuneration received early

Suppose A receives the deferred remuneration:

  • before the vesting date, or
  • before the specified conditions have been met, or
  • both.

As long as this early receipt does not cast any doubt on the genuine nature of the original deferral, it will not withdraw the cover of Section 554L from the original relevant step and there will be no retrospective charge.

But, if the early receipt does not attract PAYE, the fall-back charge will apply at the end of the final exercise date. See EIM45415.

If A receives the deferred remuneration early from P, P will take a relevant third step within Section 554C at that point. See EIM45060. If the statutory conditions are met, this will give rise to Part 7A income attracting PAYE.

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Specified conditions: conditions later lifted

Suppose:

  • an employee share option scheme meets the conditions in Section 554L(1)(a) to (e),
  • after (say) one year, some of the conditions are lifted, and
  • as at the time when the conditions are lifted, there is no reasonable chance that the award will be revoked.

Section 554L(1) imposes five conditions on the employee share option scheme (see EIM45405). You apply these five conditions at the award date. Therefore, if an employee share option scheme meets these conditions at the time when an award is made, and later on some of the conditions are lifted, that will not automatically disapply Section554L.

But you need to find out why the conditions were lifted.

  • If there is doubt about the genuineness of the conditions, the ‘main purpose’ test may be failed Section 554L(1)(c).
  • If the conditions were made, or lifted, or both in the hope of avoiding tax, the relevant step may fail the ‘tax avoidance’ test Section 554L(3).