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HMRC internal manual

International Manual

Transfer pricing: Types of transactions: share options: transfer pricing issues

Understanding the transaction, the arm’s length bargain and methodology

See INTM440210 for an introduction to how transfer-pricing rules apply to the intra-group provision of employee share plans.

In a group situation, usually, the Provider will not only set up the plan and administer it but will also make shares available as and when necessary.

For transfer pricing purposes, intra group payments (or imputed payments) should reflect the price that would have been paid at arm’s length between independent third parties. The actual intra group charge (if any) recorded in the accounts of each party will not necessarily reflect the arms length price. The price of the facility for transfer pricing purposes should reflect its overall value, in terms of what the Provider would expect to receive for providing the whole facility to a third party and what the Employer would expect to pay to obtain the facility from a third party.

Considering each of the key elements of the facility

A company providing Share Awards to a third party would expect to receive the value of the awards provided, and the Employer would expect to have to pay that amount to a third party. If it is necessary to calculate this value (see paragraphs 24 and 25 below), it should be based on the “fair value” of the awards calculated in accordance with Appendix B of FRS20 and not, in any circumstances, the “intrinsic” value.

A company providing share plan administration services would charge for these services, and the Employer would expect to pay for them. Generally, the provision of such administration services on their own would be likely to fall within the scope of guidance in INTM440090 on centrally provided services.

The Provider’s tax position

Where the Provider makes a charge to the Employer, the Provider’s tax calculation should generally follow the accounting treatment required for this. If there is no charge, or the charge is different to the arm’s length amount, then a transfer-pricing adjustment may be required.

If the accounting treatment of any charge or part of a charge of the fair value of the Share Award requires that it should have no impact on the Provider’s accounting profit (because it has to be taken to reserves), this amount will be a capital receipt. If so, in the particular circumstances of transactions relating to employee share plans, it will generally be treated as such for tax purposes (though see below). Typically, a receipt of this kind will have no impact on the Provider’s taxable profits (except where the Employer obtains a deduction for such a payment - in which case see below).

In such circumstances there should be no need for transfer-pricing purposes to calculate the value of this element of the facility. Only the remainder of the value of the facility will affect the Provider’s tax computation (typically, the value of the administration services).

Any actual or imputed charge, or part of a charge, relating to this remaining element of the facility will / would typically be taken to the profit and loss account under accounting rules and will be taxable income.

A condition for applying the treatment set out in this section is that the Provider’s expenditure in relation to the supply of its own shares into the plan (e.g. market purchases of shares) is being treated in a consistent way. That is, related share purchases are capital expenditure for tax purposes, and do not give rise to a tax deduction as a trading or other expense.

In any case where the Provider did need to make transfer pricing adjustments, any imputed receipt should be treated in the same way as an actual receipt. For example, if a payment based on the fair value of share options received at the time of grant would typically be recognised over the vesting period, then transfer pricing adjustments should be calculated by spreading the imputed payment over the vesting period.

Potential application of the arbitrage receipts rule

The arbitrage receipts rule (FA(No.2)2005/26) was introduced to address circumstances where a UK resident company would otherwise expect a benefit to arise from a payment that is not fully taxable as income or gains of the company, but gives rise to a tax deduction for the payee. To counter such tax arbitrage, the legislation provides for HMRC to issue the company with a Notice requiring the company to compute its income or gains for tax purposes as if it had received taxable income equal to any untaxed amount.

INTM440250 explains more fully how the arbitrage receipts rule applies for employee share schemes. If either:

  • the Employer’s only tax deduction is a statutory deduction similar to FA2003/SCH23 (i.e. not linked to, or dependent on, the payment); or
  • payments are consistent with the arm’s length provision and give rise to deductions that reflect both the economic substance and economic value of what is provided (i.e. payments are in line with this guidance because they are no greater than the fair value of options at the time of grant and are adjusted to reflect the outcome of vesting conditions);

then HMRC would not be expecting to issue a Notice under the arbitrage receipts rule.

However, in other cases, where

  • an Employer makes a payment for the provision of the share award,
  • the Employer obtains a tax deduction anywhere in the world in respect of that payment, and
  • all the other conditions set out in FA(No.2)2005/S26 are satisfied,

then the other company (which will typically be the Provider) should expect HMRC to issue a Notice. This may be the case whether share awards are satisfied using newly issued shares, market purchased shares, or cash; and whether the payment is made to the company, or to a trust sponsored by the company.

The Employer’s tax position

Where the Employer makes an intra-group payment for the employee share plan facility on an arm’s length basis, or imputes such a payment to implement a claim for a compensating adjustment, the interaction with FA03/SCH23 needs to be considered.

FA03/SCH23 gives a specific statutory corporation tax deduction, in computing the taxable profits of a business of whatever nature, for providing employees with shares that satisfy certain qualifying conditions. FA03/SCH23 sets out the amount of the relief, when the relief is given and to whom the relief is available. FA03/SCH23/PARA25 also states that no other deductions can be claimed in respect of the costs of providing the shares either by the Employer or any other company.

For the avoidance of doubt, if the Provider makes a charge to the Employer, then the amount of this charge relating to the share award element of the facility falls to be disallowed under Paragraph 25 of Schedule 23 as the “cost of providing shares”.

The remaining part of the charge, for administration services is not affected by FA03/SCH23/Para25, and therefore the question of whether or not it is deductible for tax purposes falls to be considered under normal tax rules.

In any case where a charge is made for a facility of this nature and the value of the “Share Award” element cannot be distinguished from the value of the Administration Services, then the whole amount will be treated as the “cost of providing shares” and will be disallowed under FA03/SCH23/Paragraph25.

Where FA03/SCH23 does not apply to deny a deduction for the share award element of a payment, then, depending on the circumstances, other rules such as FA03/SCH24 may be relevant.

Employer - compensating / corresponding adjustments

Where a UK Provider is required to make any transfer pricing adjustment in their tax computation, a UK Employer may be able to claim a compensating adjustment and calculate its taxable income on the basis that it had made a payment equal to the charge that the Provider is assumed to have made. If the provision is made cross border the Employer may be able to claim a corresponding adjustment under a Double Taxation treaty.

Where a compensating or corresponding adjustment is made there should be no difference to the result for tax purposes whether an arm’s length payment is made or transfer pricing and compensating / corresponding adjustments are made. In particular, the impact of FA03/SCH23 and taking the share award element to reserves will be the same as if an equivalent actual payment had been made.