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HMRC internal manual

Employment Related Securities Manual

From
HM Revenue & Customs
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Post Acquisition Benefits from Securities

Exclusions: otherwise chargeable to Income Tax: avoidance

From 2 December 2004 the “otherwise chargeable to Income Tax” exemption (see ERSM90200) does not apply where something has been done which affects the employment-related securities as part of a scheme or arrangement the main purpose (or one of the main purposes) of which is the avoidance of tax or National Insurance contributions.

Dividends from shares used for avoidance

Where dividends from special purpose vehicle companies (set up to pay bonuses), or dividends from special shares in an employing company, are used for avoidance (being disguised cash bonuses or additional remuneration) Chapter 4 applies and the dividends are liable to full Income Tax and NIC. The charge could be in addition to the tax on the dividends under

  • Chapter 3 Part 4 ITTOIA 2005 (old Schedule F) (normally an effective rate of 25% for higher rate taxpayers and nil for lower rate taxpayers), or
  • Chapter 4 Part 4 ITTOIA 2005 (old Case V of Schedule D)

because the legal form of the benefit is not changed by the legislation. However (seeExample 1 below) the general earnings charge will still be the primary argument in such cases.

Example 1: avoidance of tax and NIC on cash bonuses

In the past some companies gave their employees forfeitable shares in special purpose vehicle (SPV) companies, whose assets were simply the cash bonuses that would have otherwise been paid to those employees, and were instead paid out as dividends.

It has been argued that for pre-2 December 2004 avoidance schemes which use SPVs to disguise cash bonuses as dividends, there is no further charge because the dividend paidis ‘otherwise chargeable to income tax’. So for a lower rate taxpayer there might be no Income Tax or NIC and for a higher rate taxpayer only 25% Income Tax liability. In such schemes the employer also attempts to escape PAYE and NIC payments.

HMRC does not believe such arrangements are effective in reducing income tax or NICs liability or avoiding PAYE obligations and is pursuing enquiries relating to the use of such schemes.

The primary argument should be to treat such dividends as general earnings. For dividends paid on or after 2/12/04 under such an avoidance scheme, the amount of the dividend may, in the alternative, count as employment income of the employee chargeable to Income Tax under Chapter 4 Part 7 ITEPA 2003.

There may also be a further amount treated as earnings from the employment under ITEPA03/S222 if any amount of the PAYE tax that the employer is unable to deduct from other payments made to the employee had not been made good by the employee to the employer within 90 days of the dividend being paid.

Example 2: avoidance of tax and NIC on supplementary wages

Avoidance schemes exist where employers set up schemes to give employees shares in theemployer company that have negligible rights other than the ability to receive dividends at the discretion of the employer. Employee A receives one A-share, employee B one B-share and so on. The employees are paid a small rate of pay, which is topped up each month by a dividend individually tailored to that employee.

Again, the primary argument should be to treat such payments as thinly disguised general earnings. Alternatively, from 2 December 2004, the dividend will be liable to Income Tax under Chapter 4, on which PAYE will be operable. NIC will also be due.

There may also be a further amount treated as earnings from the employment under ITEPA03/S222 if any amount of the PAYE tax that the employer is unable to deduct from other payments made to the employee had not been made good by the employee to the employer within 90 days of the dividend being paid.

Example 3: composite company

Following the introduction of the Intermediaries Legislation (commonly referred to as IR35) in April 2000, attempts have been made to circumvent its provisions. Many composite companies pay dividends to the contracted workers in place of income subject to PAYE and NICs in an attempt to avoid the IR35 provisions. In such circumstances, a Chapter 4 benefits charge may arise.

NICs and PAYE

Any NICs liability due on payments in the period 2 December 2004 to 20 July 2005 will not arise until regulations, provided for within the National Insurance Contributions Act 2006, have been introduced. The Act received Royal Assent on 30 March 2006 and the relevant provisions are expected to be in place by early 2007. In the meantime, until the retrospective regulations are in force, any NICs liability will only arise in respect of payments made on or after 20 July 2005 (date of Royal Assent of the Finance (No.2) Act 2005).

Any PAYE liability in respect of benefits held to be received between 2 December 2004 and 20 July 2005 and chargeable under s.447 ITEPA by virtue of the amendment introduced by F(No.2)A 2005 will not arise until PAYE regulations are introduced simultaneously with the NICs regulations.

Payment of NICs and PAYE liabilities, and submission of returns reflecting those additional liabilities’, will arise prospectively from the date regulations are introduced.