12 November 2020
Potential significant tax changes for share plans operating in UK
The UK Office of Tax Simplification (OTS) has produced the first of its reports into the reform of capital gains tax (CGT). The Government has charged the OTS with finding ways of raising more revenue to help cover the costs it has incurred during the pandemic and the OTS makes recommendations which could lead to increases in CGT rates, loss of several types of CGT relief and also dramatically impact certain types of employee share planning arrangements in the UK. The report is available for download here.
The key news is the OTS wants the Government to look at aligning CGT and Income Tax. This is likely to result in potentially big increases to CGT rates and reductions in CGT reliefs such as the annual exempt amount.
The headline news for incentives is the OTS recommending the Government to:
- consider the effectiveness of tax-advantaged plans - the all employee Sharesave and SIP in particular
- increase the ways in which certain employee share awards are subject to Income Tax; and
- tax owner manager and employee reward more consistently.
Any of these measures could result in major changes to employee incentives in the UK.
This report – the first of two reviews of CGT - was commissioned by the Chancellor of the Exchequer in July to “identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent.” (see our alert: here).
This report is on the policy design and principles underpinning CGT and the second report will explore key technical and administrative issues and will follow next year.
Findings and Recommendations
The OTS reports a range of areas in which CGT is counter-intuitive, creates odd incentives, or creates opportunities for tax avoidance. In particular, the OTS said that the disparity in CGT and Income Tax rates can distort behaviour and create an incentive for taxpayers to effectively re-characterise income as capital gains.
The report makes a series of observations and recommendations, the most eye catching of which relate to:
- ensuring greater alignment between CGT and Income Tax,
- reducing, replacing or abolishing reliefs such as the annual exempt amount and Business Asset Disposal relief (the new name for entrepreneurs’ relief); and
- removing the uplift on asset values on death.
From a share plan perspective, the key item and potentially big news is Recommendation 4, which says:
- the Government should consider “… taxing more of the share-based rewards arising from employment, and of the accumulated retained earnings in smaller companies, at Income Tax rates”.
Tapestry’s view is that this Recommendation 4 is not perhaps as scary as it sounds. Most employee share awards are already subject to Income Tax in the UK at the time of delivery (like options and conditional awards). We think this recommendation is primarily aimed at:
- growth share plans and similar arrangements; and
- using small close and personal service companies to deliver retained earnings as capital rather than income.
The background to the Recommendation is covered in detail in Chapter 3 of the report. This sets out an explanation of the main forms of share-based awards and how they are taxed. It comments that, unlike share options and other future share rights (like conditional awards) which are largely subject to Income Tax and national insurance contributions (NICs), certain types of upfront share awards can result in employment reward being deferred, accumulated and subject to CGT rather than to Income Tax.
Tax advantaged plans – changes ahead?
The worrying commentary is found in the OTC statements concerning tax advantaged plans.
The report notes that there are public social and economic justifications for supporting the use of tax advantaged all-employee share schemes such as Sharesave and SIP.
Alarmingly, the report appears unconvinced of the merits of these arguments. It questions whether such plans are the most cost-effective approach to helping people save or encouraging long term share ownership (it states that 38% of Sharesave participants sell their shares immediately after they acquire them instead of focussing on the 62% who keep their shares). It notes that millions of lower paid employees (including those in the public sector, or professional partnerships, or private equity backed companies) cannot access them. In our view, although there is no explicit recommendation being made, the implication is clear - that the Government should revisit the effectiveness and scope of tax advantaged plans, generally. In the context of the CGT review there is a clear risk the tax reliefs available under plans like SIPs and Sharesave may be removed or reduced. As we note in our comment below – we will seek to counter this view, strongly.
Growth shares under scrutiny
The report particularly focuses on growth share plans. These are plans designed to deliver shares which, broadly, benefit only from increases in the company’s value from the date of award. They are intended to have little value on acquisition, with little or no Income Tax or NICs to pay at that time. When the shares are sold, there will be a capital gain based on the difference between the (hopefully high) sale proceeds and (relatively low or nil) amount paid for them. They attract minimal Income Tax or NICs, with all their growth in value instead being subject to CGT (which is currently at a lower rate of tax). In conclusion, the OTS offer a negative view: “growth shares are similar to share options, as they involve what is likely to be a low tax charge on award with little risk to the employee.” With this report, the likelihood of legislative intervention into such plans has increased considerably. We will watch this space for more detail to see how and the extent to which the Treasury and HMRC make their move and whether similar plans like the jointly owned share plan (which uses a trust arrangement to achieve a similar outcome to growth shares) might be included in such measures.
Personal and closely held companies
The OTS notes that personal service and closely held companies can be used to deliver retained earnings in a tax efficient way. The report states that: “The ability of those conducting their business through Personal Service Companies to roll up retained earnings into what becomes a capital gain produces an additional tax benefit for those with the means and the desire to secure it.”
There have been numerous legislative moves to drive a “fairer” tax status for small personal or closely held companies. The OTS is the latest to add its voice to this issue. It does at least recommend that the scope of any measures in this area should not extend to large publicly listed companies.
The OTS notes there are “policy justifications for non-neutrality” in approaching CGT, particularly for tax advantaged all-employee share plans. It notes that any changes to employee share schemes or accumulated retained earnings in close companies would require much more careful consideration and analysis. Nevertheless, the OTS is clear that it regards arrangements like growth share plans as anomalous – they allow shares to be made available to employees on better terms than to other investors, and add to the pressure on the boundary between Income Tax and CGT.
But the report presents evidence that the tax reliefs available under the UK’s suite of tax advantaged share plans is also under scrutiny. There is a real risk that the Government may conclude that certain of the tax reliefs under these plans – the Sharesave and Share Incentive Plan (SIP) in particular – are inefficient, wasteful and do not deliver the stated policy aims for those plans. This is a conclusion which we believe is not supported by evidence and, as discussed below, needs to be strongly rebutted.
The report notes the different aims given to CGT over the years, from ensuring parity between taxing income and gains, to driving risk taking and promoting enterprise. This report leaves the reader in little doubt that the aim of the present administration is more mundane – to deliver efficiency and rationalise the system but above all, increase the tax take. The primary conclusion of Chapter 3 of the Report is that retaining a substantial difference in rates between Income Tax and CGT may put pressure on the boundaries between the two taxes. The implication is that the status quo cannot stand as it leads to distortions and unfairness.
The commentary concerning employee share plans is initially unsurprising. The OTS acknowledges share-based remuneration is a complex area. A key recommendation is to align the tax treatment of income and capital, and the observations concerning employee share plans (particularly using closely held small companies and growth shares) is aligned with this recommendation.
The focus on growth share planning arrangements is to be expected: they have been on HMRC’s radar for over 10 years and the OTS commentary must surely mean that the CGT-driven outcome of these and similar arrangements is not much longer for this world. Similarly, the comments concerning the disparity in tax between incorporation and employment and how closely-held companies can produce outcomes which distort behaviour, reflect an ongoing and widely heard debate in terms of how best to tax such enterprises fairly without limiting entrepreneurship.
Much more alarming and unheralded are the comments concerning tax advantaged plans - SIPs and SAYE, in particular. The report does acknowledge the policy goals of such plans but the overall tone is clearly one of the unconvinced sceptic. The report acknowledges that a whole swathe of UK employees cannot access these types of plans. In our view that is precisely the problem and the solution should be to broaden and strengthen them, not limit or reduce them! We will be working with our friends at ProShare and other industry representatives to ensure that the Government is convinced of the clear merits and compelling arguments not only to retain these incredibly popular plans but to extend their scope and the extent of their reliefs. The report glosses over the documented positive impact of employee ownership on economic performance and Tapestry’s long held view is that, at a time when harder work and greater productivity is vital, these plans are needed more than ever.
We want to represent the share plans industry and welcome views from our clients. If you would like to get in touch to discuss this, we would be delighted to hear from you to make our collective voice heard.
Sarah Bruce and Chris Fallon