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HMRC internal manual

International Manual

Transfer pricing: Types of transactions: share options: general

Scope and relationship with previous guidance

This guidance explains how transfer-pricing rules apply to the intra-group provision of employee share plans. It also considers the implications of Financial Reporting Standard 20 (FRS20), Schedule 23 of Finance Act 2003 (Corporation Tax deductions for the cost of employee share schemes), and Section 26 of Finance (No. 2) Act 2005 (the arbitrage receipts rule).

These pages replace all previous guidance on the application of transfer pricing rules to employee share plans - including for the purposes of calculating the ongoing impact on profits of share options granted in earlier accounting periods. But this new guidance is not applicable for accounting periods beginning before 1 January 2005 even where tax returns are still open for those periods.

There are some changes from earlier guidance. For example, we previously distinguished between plans using solely newly issued shares and other plans, while this guidance does not. Where employee share plans involve share options this new guidance no longer allows intra-group transfer prices to be based on the costs of borrowing to hedge the options, and any actual or imputed payment for the options will constitute a “cost of providing shares” for the purposes of FA03/Sch23.

If companies have granted options in an accounting period beginning before 1 January 2005, earlier guidance should not be applied for the duration of those options. For accounting periods beginning from 1 January 2005, if any transfer pricing adjustments are required in respect of pre-existing options, then they should be based on appropriate recognition of an imputed payment made at the time of grant, based on the fair value at the time at the time of grant.

The changes have been made to take account of developments since earlier guidance was originally prepared, including the introduction of FRS20 and dialogue with stakeholders. This guidance applies for accounting periods commencing on or after 1 January 2005, whether or not a company has adopted IFRS2/FRS20, and in implementing this guidance companies should consider the actual accounting requirements relevant to their accounts in the particular year concerned.

A typical scenario

An employee share incentive plan can take a number of different forms, including shares, share options, and “phantoms” (cash payments based on the rise in share prices over a period). The term “share-based payment” is used here to cover the range.

In a group situation the employing company (“Employer”) is commonly a subsidiary and the shares that are used are usually those of the group holding company or parent - or sometimes of an intermediate holding company. In most group cases the plan will be provided by the holding company or parent to its subsidiaries, enabling share-based payments to pass to its employees (if any) and to employees of group members. In this guidance the group member providing the plan is called the “Provider”.

Why transfer pricing issues arise

However the arrangements for administering and delivering an employee share plan within a group are set up, a facility is being provided, and transfer pricing rules will apply. Case law (the Special Commissioners’ decision in the case of Waterloo plc (1) Euston Ltd (2) Paddington Ltd (3) v Commissioners of the Inland Revenue, 2001)(SpC 301) establishes that the facility should be priced accordingly for the purposes of applying transfer pricing rules, with the Provider receiving or imputing receipts that reflect the full value of the facility it is providing.