Annual employee share plan reporting can highlight errors in the tax treatment of underlying transactions. This article explores common corporation tax errors often discovered during the annual share plan reporting process and suggests how companies can address them.
In-house corporation tax teams might find it useful to share this article’s companion piece on employee share plan payroll errors with their payroll and employment tax colleagues.
Before diving into potential errors, it's important to understand the three main ways companies can claim corporation tax relief for employee share plan costs.
Tax-advantaged Share Incentive Plans (SIPs)
Firstly, there’s a specific regime for ‘Schedule 2 SIPs’, which are share acquisition plans that meet certain conditions for favourable income tax and capital gains tax treatment. The rules for claiming corporation tax relief for providing employee shares through a SIP are involved, and companies frequently make errors. However, as this regime for claiming corporation tax relief has only a narrow application, this article doesn’t delve into these rules in detail.
The Corporation Tax Act 2009, Part 12 (Part 12)
Secondly, a specific regime exists for qualifying employee share acquisitions outside a SIP. Broadly, if all applicable conditions are met, the employer can claim a corporation tax deduction equal to the market value of the shares on the date they are acquired by employees, minus any amount the employees pay for them. The conditions for this relief include that the employee acquires a beneficial interest in fully paid-up, non-redeemable, ordinary shares.
Other employee share plan costs
Thirdly, for other costs of running an employee share plan (e.g. administration, brokers’ fees, and providing shares that don’t qualify for specific deductions under the SIP or Part 12 rules), employers might be able to claim relief under general principles for charges to the income statement that are incurred wholly and exclusively for the purposes of its trade, and which represent revenue rather than capital expenditure.
Preparing annual employee share plan returns can uncover:
Share-based awards are ‘net-settled’ if, rather than being settled wholly in shares, they are partly settled in cash that the employer keeps back to cover the PAYE and employee’s NIC due (so settlement in shares is ‘net’ of payroll withholding).
Because the employee doesn’t acquire a beneficial interest in all the shares that were subject to the award, any Part 12 deduction is limited to the value of shares beneficially acquired. This means that, where available, the employer must claim a general principles deduction for the cash cost of net-settlement. But based on HMRC’s guidance, any general principles deduction for the cash cost of net-settlement could be less than the Part 12 deduction that would otherwise have been due if the employee had beneficially acquired all the shares under the award.
A key issue for employers is often establishing whether a share award is, in fact, ‘net-settled’. This might not be obvious and might not be straightforward to confirm, as detailed discussions might be needed with the group’s share plan administrators, company secretarial function and potentially others to establish the position. Some corporation tax teams who establish that they ‘net-settle’ awards might therefore uncover that they’ve overclaimed corporation tax deductions under Part 12 in the past, as they were then unaware that some, or all, employee share awards are net-settled.
IMEs can raise specific issues for corporation tax compliance.
Share awards held by IMEs when they arrive in the UK can give rise to Part 12 deductions for their host employers that could be overlooked. Any such deduction is based on the amount charged to UK tax as employment income.
So, making sure that any Part 12 deductions available for in-bound IMEs’ awards are identified and claimed needs a robust process for identifying IMEs who arrive in the UK holding share awards, tracking when those employees acquire the underlying shares, and calculating a deduction based on the amount subject to UK income tax. The interaction with any recharge payments made to a host employer may, however, need to be considered before taking a Part 12 deduction.
On the other hand, IMEs who leave the UK with share-based awards can potentially give rise to Part 12 deductions for the full ‘gain’ they receive, even if this is not fully charged to UK income tax. Therefore, it’s important to make sure that out-bound IMEs’ share awards are tracked for trailing corporation tax deductions as well as any ongoing UK payroll obligations.
Where there might be employer deductions for the same share-based employment income in the UK and in the IME’s home or host country, international groups should confirm the extent to which it would be possible to claim in each jurisdiction (and UK and other anti-avoidance rules can be relevant here).
Specific consideration may also need to be given to other scenarios e.g. branches or employees who spend part of the vesting period working in the UK but are not present at either grant or acquisition of shares.
Part 12 is the most common basis on which corporation tax deductions are claimed for employee share acquisitions so companies sometimes overlook the separate SIP rules (see above) and claim deductions for SIP share awards under the Part 12 regime. Depending on the how shares are sourced to satisfy SIP awards, deductions mistakenly claimed under Part 12, instead of under the SIP rules, can end up with the employer over or underpaying corporation tax.
Companies should satisfy themselves that they could show HMRC that their systems and processes for calculating employee share plan deductions, which might be a significant figure, are robust. This is especially important for companies that are within the Senior Accounting Officer regime.
Specific questions that corporate tax teams can consider include:
We have extensive experience partnering with companies to remediate employee share plan corporation tax compliance issues. Please contact the authors, or your usual KPMG in the UK contact, to discuss how we could support you with your employee share plan arrangements.
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