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HMRC internal manual

Employment Income Manual

Employment income provided through third parties: exclusions: earmarking for employee share option schemes: specified exit events: overview and conditions

Section 554M ITEPA 2003

Conditions

The Section 554M exclusions: introduction

Section 554M exclusion for actual grants

Section 554M exclusion for expected grants

Connection with tax avoidance arrangement

Section 554M: 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 554B gateway.

But this step will not give rise to Part 7A income if all the conditions of Section 554M are met.

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

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

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Conditions

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

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

Section 554M(1)(a)

There is an arrangement (‘B’s employee share option 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’ which are not units in a collective investment scheme, or
  • to receive 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 Section554M(1)(a) it cannot.

It does not matter whether the grant may be made 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 554M(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 554M(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 (seeERSM20140).

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 554M(1)(d)

The grant would be on terms (‘the deferred grant terms’) the main purpose of which is to ensure that A cannot exercise the relevant share option unless:

  • a specified exit event occurs, or
  • an exit event within a specified description occurs.

On the ‘exercise’ of options, see EIM45460.

On ‘exit events’, see EIM45465.

If A exercises the relevant share option early, see EIM45440 (in particular, cases 1 and 2).

Section 554M(1)(e)

As at the time the grant is made, 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 554M exclusions: introduction

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

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Section 554M exclusion for actual grants

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

  • The relevant step is within Section 554B.
  • But for Section 554M, 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 554M(1)(a).
  • Second, this grant meets the requirements of Section 554M(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 grant.

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

On ‘solely’, see EIM45320.

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

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Section 554M exclusion for expected grants

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

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

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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 Section554M, 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 554M: later events

If a Section 554M 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 EIM45440.

A fall-back charge may apply if a relevant step comes within the Section 554M exclusion for expected grants but the grant is delayed. See EIM45445.

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 EIM45450.

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