Ken Moody unearths some, perhaps unconsidered but not trifling, issues readers should be aware of.
As some readers will know, the employment-related securities (ERS) legislation (ITEPA 2003, Pt 7) is very complex. It is also fundamentally flawed in various ways, and it is quite easy to fall into traps which are rather like ticking time bombs, ready to explode when it’s too late to defuse them.
Legislation in ITEPA 2003, s 421B(3) basically deems any acquisition by an employee of shares or other securities in their employer to be acquired ‘by reason of employment’. In many situations, shares acquired by company shareholder-directors are not acquired by reason of employment as a matter of fact. For example, on incorporation of a sole trader or partnership business, the shares acquired in the new company are acquired as owners of the business. The acquisition of such ‘founders’ shares may not be reportable (see ERSM140040), but they are still ERS by definition.
Family company shares
There is a very important exception, however, in s 421B(3)(b) for securities acquired under a right or opportunity made available ‘in the normal course of the domestic, family or personal relationships of that person’ (i.e. the employee).
The exception would cover the ‘plain vanilla’ situation where shares in a family company are handed down from father to son (who is also an employee or director) as part of succession planning. Whether the exception applies in particular circumstances is a question of fact, but there is no ‘closure’ available as there are no immediate consequences if the view is taken that the exception does apply. But HMRC might challenge the position later.
Muddied waters
The exception applies, however, only to an acquisition under a right or opportunity made available by an individual. Nevertheless, if in the above circumstances the shares were issued directly by the company, prior to August 2012 the HMRC guidance accepted that the exception would apply. The guidance was updated in August 2012 to remove ‘inaccurate text on companies controlled by individuals’ and under ERSM20220, as it now reads, if the company issues the shares directly to the son the exception would not apply, which is in accordance with the legislation.
However, to muddy the waters further, the guidance on completion of the annual online ERS template appears to revive the pre-August 2012 guidance in accepting that the exception will apply where a company is controlled by an individual or a family and ‘that individual or family have procured the award of the securities or grant of the option’ (ERSM140070).
So, which is it? If that is what it says at ERSM140070, why does it say something different at ERSM20220?
It would, of course, be possible to issue any additional shares to the father (in the scenario described) and for him to gift the shares to the son. This would be a disposal at market value for capital gains tax (CGT) purposes, but the gain may be held over (under TCGA 1992, s 165) provided that the company is a trading company. Otherwise, as the HMRC guidance at ERSM140070 is the latest guidance, one may be able to argue ‘legitimate expectation’.
Ticking time bomb
There is another ticking time-bomb I should mention, because I doubt that it has occurred to many people, though HMRC are aware of it. Shares acquired by an employee for less than their market value are taxable as earnings on long-established principles (e.g. Weight v Salmon (1935) 19 TC 174). There are circumstances where the exception at s 431B(3)(b) does not apply, but where there would normally be no charge on acquisition (e.g. if shares are acquired by the employee from an estate or family trust). The shares would therefore be within the definition of ERS, but as no charge arises on acquisition if the shares are restricted securities, the workings of ITEPA 2003, Pt 7, Ch 2 result in the entire gain on disposal of the shares being subject to income tax rather than CGT. Of course, this is not intentional but is simply a logical consequence of the legislation.
HMRC’s Employee Shares & Securities Unit have confirmed to me that they take a sympathetic view of such situations, but that is not how it should work and cannot be relied upon.
Practical Tip:
It is probably a vain hope that the legislation will be amended any time soon. Otherwise, the answer could perhaps be an application for informal clearance in such circumstances at the time the shares are acquired, or to try to ensure that the shares are not restricted securities in the first place. For example, private company shares which are subject only to the directors’ right to refuse to register a transfer (Article 26(5) of the Companies Act 2006 model article for private companies) are probably not restricted securities.
