Restricted Securities: Conditional shares acquired between 17 March 1998 and 16 April 2003: specific issues dealt with in Tax Bulletin 46
|Comparison between Sections 140C(3) and 140C(3A) ICTA 1988|
|Articles of Association|
|Company leaving the Group|
|Interaction between S140A and S162 ICTA 1988|
|Interaction between S140A ICTA 1988 and S78/S79 FA 1988|
Comparison between Sections 140C(3) and 140C(3A) ICTA 1988
To fall within S140C(3) ICTA 1988, it is necessary for the articles of association to require that an employee who leaves employment must offer the shares for sale. This implies that it is not possible to differentiate between different classes of leavers. For example, some employers will want all leavers to sell their shares while others will be content to allow employees who leave through ill health, disability etc. to retain theirs. In contrast, the wording of S140C(3A) appears to allow some discretion in this matter. Does HMRC allow the same discretion as to which employees must sell their shares under both subsections of the Act?
We do not draw any distinction between the ‘requirement’ tests in S140C(3) and S140C(3A) and accept that both subsections allow for the possibility of differentiating between classes of leavers.
The term ‘misconduct’ is used in S140C(3A) ICTA 1988. Many share plan rules refer to ‘termination for cause’; does HMRC interpret ‘misconduct’ to include ‘termination for cause’ for this purpose?
We would agree that the term ‘termination for cause’ falls within the scope of S140C(3A).
Many companies require that employees who own shares must sell them for a price determined by a formula if they cease employment. Provided these provisions are contained in the articles of association, this alone will not make the shares conditional. However, such companies often provide that the shares must be sold if the employee becomes bankrupt. This would not, on the face of it, fall within any of the exemptions of S140C(3) ICTA 1988. A director who was made bankrupt would have to cease to be a director, because of the prohibition in the Company Directors Disqualification Act of 1986, but could normally continue as an employee of the company.
This means that if shares owned by an employee were conditional solely because of a bankruptcy condition, they would not be conditional if the employee were also a director, because they would now fall within the exemption of S140C(3).
Would HMRC propose an amendment or introduce a concession that a bankruptcy provision contained in the articles of association would be ignored for the purposes of determining whether the shares were conditional for an employee who is not also a director?
We can confirm this interpretation of the legislation. There are no plans to introduce a concession or to amend the legislation.
Some shares are subject to ‘drag-along’ rights. These rights typically require that a minority shareholder must sell some or all of his shares if other shareholders sell their shares to a third party. The price for such a sale is normally the price paid by the third party and, as such, is not normally discounted to take account of a minority interest, for example. Would such ‘drag-along’ rights, on their own, make the shares conditional?
Conditions may apply which potentially require shareholders to sell their shares when the majority shareholders sell out and at the same price as those shareholders. Where that requirement is, in effect, a requirement to offer shares at a genuine arms length price then the test in S140C(1)(b) would not be met so that the provisions of S140A would not apply.
Articles of Association
The term ‘articles of association’ is used in S140C ICTA 1988. How does HMRC interpret this term in relation to foreign companies that may not have articles of association, but have other documents such as ‘bye-laws’? How does this interpretation fit with the Treaty of Rome?
HMRC does not treat agreements outside articles of association as if they were in articles of association for the purposes of S140C. The exemption in S140C(3) is not extended to foreign company equivalents.
With regard to the Treaty of Rome, the Revenue treats EU resident companies no differently from UK resident companies that have forfeiture rules outside of Articles of Association.
The term ‘articles of association’ is also found in paragraph 12 of Schedule 9 ICTA 1988, in the context of the approved share scheme legislation. HMRC interprets the term to include equivalent foreign documents for this purpose. What is the reason for this difference between the two circumstances?
The reason for the difference between the interpretation for S140A and approved scheme legislation purposes is the difference in rationale for these two parts of the Taxes Act.
If employees receive shares on terms that mean those shares may be forfeit, it is right that the full value of the shares should be treated as remuneration and charged to income tax when that risk is subsequently removed. The Government was, however, concerned that employees in many small private companies, which have for a number of years been awarding shares, would be caught by S140A because of pre-emption rights in the articles of association. Where this represented the only risk of forfeiture, it has always been accepted that the income tax charge arose on the value of the shares when they were received. As a result it was decided to exclude from the new provisions the situation where an employee acquires shares that are conditional solely as a result of conditions contained in the employing company’s articles of association. The limits of the exemptions in S140C as interpreted by HMRC do, generally speaking, exempt those small private companies with pre-emption rights.
The purpose of paragraph 12 Schedule 9 is to ensure that the shares that employees receive through approved schemes are normal shares on normal terms. This is reflected by the requirement that they must not be subject to restrictions, unless those restrictions attach to all shares of the same class. For this purpose the restrictions are not only those included in the articles of association but also those imposed by other documents or agreements (paragraph 13 Schedule 9). This applies equally to UK and foreign companies.
Company leaving the Group
Some companies have articles of association that require employees to sell their shares if the subsidiary that they work for is sold or ceases to be a 51% subsidiary. This does not appear to fall within the exemption in S140C(3) ICTA 1988, since the employee does not cease to be an employee. Instead the company that he works for ceases to be a group company. Would this situation mean the shares were conditional for the purposes of S140A?
Where the requirement is, in effect, a requirement to offer shares at a genuine arms length price, the test in S140C(1)(b) would not be met so that the provisions of S140A would not apply.
It would be unusual for the requirement to meet the test in S140C(1)(b), but where that happens, the acquisition of shares would fall outside the exemption in S140C(3) and therefore within the scope of S140A.
Interaction between S140A and S162 ICTA 1988
Section 140A(3) ICTA 1988 contains a reference to Section 162 ICTA 1988. Does this apply to the difference between the full market value of the conditional shares and the amount paid, or merely act to retain the charge which would otherwise apply under S162?
The provisions at S140A do not extend the circumstances in which a S162 charge can apply to shares acquired at an undervalue.
The normal rules charge which arises under S19 takes priority over any S162 charge because of the operation S162(11). S140A then goes on to displace the S19 charge in certain circumstances but it does not extend the scope of S162. It merely retains the S162 charge that would apply in normal circumstances.
Interaction between S140A ICTA 1988 and S78/S79 FA 1988
Many share plans operate over shares in subsidiary companies. These share plans may be operated for genuine commercial reasons and in some cases the shares that the employees own will be conditional.
If an employee sells the shares then an income tax charge would appear to be due under both FA88/S79 and ICTA88/S140A. Each of these sections contains provision to allow a tax charge under the other in calculating the tax charge. What is the correct treatment when the tax charge arises at the same time under both sections?
A similar situation can arise in respect of a tax charge under FA88/S78, where share rights are altered. For example, a company’s share capital may be changed on a flotation. This may give rise to a ICTA88/S140A charge, if the shares cease to be conditional, and a FA88/S78 charge on a variation in the rights attaching to those shares. How does the legislation apply such a case?
Section 79 (6A) FA 1988 provides that the S79 charge will be reduced by any amount charged under S140A ICTA 1988 if the S140A event occurs before the time of the S79 chargeable increase.
The deductible amounts for the S140A charge in respect of events for which there is a charge under S79 (and S78) FA 1988 are for those events which have occurred not later than the event giving rise to the S140A charge. This order of priority is found at S140A(7)(c).
Therefore, where a S79 charge arises at the same time as the S140A charge, the full S79 charge will be taken, and that charge will be deductible in computing the S140A charge.
Where a chargeable event for S78 FA 1988 purposes occurs at the same time as the risk of forfeiture is lifted, the full S78 charge will be taken and that charge will then be deductible in computing the amount for S140A.