New HMRC guidance on net-settled and cash cancelled employee share awards

Do you claim Corporation Tax relief for employee share plan costs in line with HMRC’s new guidance? Here’s what you need to know

HMRC guidance on employee share plan costs

HMRC have published new guidance on Corporation Tax relief for the cash cost of net-settling and cash cancelling employee share awards. This confirms that ‘general principles’ of Corporation Tax relief may be available and sets out HMRC’s view on its quantum and timing. This new guidance is welcome as the first indication of HMRC’s views in what was previously an uncertain area. However, some aspects might give rise to practical difficulties. Companies who net-settle or cash cancel share-based awards should review whether any associated Corporation Tax deductions they claimed before this guidance was released are in line with HMRC’s newly published positions and, if not, consider what actions would be appropriate.

Statutory Corporation Tax relief for employee share plans

Where employees acquire shares under an employee share plan (e.g. when options are exercised or Restricted Stock Units (RSUs) vest), the employer can often claim statutory Corporation Tax relief for the difference between the value of the shares on acquisition and any acquisition price paid.

Several conditions must be met, including that the employee acquires a beneficial interest in the relevant shares. If an employee does not acquire a beneficial interest in all the shares underlying their award – for example if the award is net-settled or cash cancelled – statutory Corporation Tax relief will not be available for the full value of the award.

Net-settlement and cash cancellation

A share-based award is ‘net-settled’ if the employer settles part of the award in cash that it withholds and remits to HMRC in respect of its PAYE and NIC obligations (this differs from ‘sell to cover’ where the employee acquires a beneficial interest in all the relevant shares, but some are sold on their behalf to cover the withholding). 

For example, if an employee is awarded RSUs over 1,000 shares which vest when the shares have a market value of £10 each, and the entire £10,000 that counts as employment income is subject to payroll withholding at a marginal income tax and employee’s NIC rate of 47 percent, it could be ‘net-settled’ by the employer:

  • Cancelling part of the award in return for a cash payment of £4,700 which it withholds to cover the PAYE and NIC; and
  • Settling the net value of the award of £5,300 by issuing 530 shares worth £10 each to the employee.

In these circumstances, the statutory Corporation Tax relief is limited to £5,300 (i.e. the value of the shares issued) as the employee did not acquire a beneficial interest in 470 of the underlying shares. 

With cash cancellation the entire share-based award is settled in cash without the employee acquiring a beneficial interest in any shares. This might be done for administrative ease, for example where a company is taken over to avoid issuing new shares which would immediately be purchased from employees by the acquirer.

In these circumstances, the employer will need to confirm whether a ‘general principles’ Corporation Tax deduction is available in respect of the cash cost of net-settlement or cash cancellation. In summary, a deduction can be claimed on this basis if:

  • A corresponding amount is debited to the employer’s income statement;
  • The expense represents revenue (rather than capital) expenditure incurred wholly and exclusively for the purposes of the employer’s trade;
  • A deduction is not specifically disallowed; and
  • A deduction which would otherwise be available is not specifically deferred.

What does HMRC’s new guidance say?

The new guidance on net-settlement and cash cancellation confirms HMRC’s views on identifying the relevant accounting debit, determining how much of it can be deducted (assuming all relevant conditions are met), and the timing of any relief.

In summary, the starting point is to identify share-based payment charges to the income statement that represent awards which were net-settled or cash cancelled. For some employers, this could be challenging if the relevant debits are aggregated with other charges for awards that have yet to vest or were delivered entirely in shares, and a detailed breakdown is not easily available.

The maximum amount of the relevant debits that can be deducted under ‘general principles’ is based on the portion of the award that was delivered in cash rather than shares (e.g. for a net-settled award that was subject to an effective withholding rate of 47 percent that portion would be 47 percent, and for a cash cancelled award that portion would be 100 percent). However, any deduction is ‘capped’ at the cash amount that counts as employment income in the employee’s hands on net-settlement or cash cancellation.

On timing, HMRC’s guidance indicates that general principles Corporation Tax relief can be taken only when an award is net-settled or cash cancelled, but remains spread across the accounting periods in which the accounting expenses were recognised, rather than taken in full in the year in which the award is net-settled or cancelled. This could cause practical difficulties, as it may not always be possible to amend submitted returns to claim a deduction for earlier years. 

Limiting any general principles deduction to the relevant accounting charge (which is expected) and HMRC’s view on when a deduction may be claimed, mean that in many cases employers will be unable to obtain a deduction for the full cash cost.

Although separate from their guidance on net-settled and cash cancelled awards, HMRC also issued other comparatively recent guidance confirming that a Corporation Tax deduction for employer’s NIC due on share-based awards should follow the accounting treatment (so it’s incorrect to take relief for employer’s NIC costs all in the year of payment).

What should employers do now?

HMRC’s new guidance is welcome but appears to have limitations. For example, it discusses only awards that are structured as ‘share options’ for tax purposes. This covers any right to acquire shares (e.g. many RSUs), but in our view the treatment of awards that are not classified as ‘share options’ could well differ. We are engaging with HMRC to clarify this and other points.

Employers should review the Corporation Tax treatment of their employee share plans. Specific questions to consider include:

  • Do you net-settle any share-based awards? This can be difficult to determine, particularly where an overseas parent operates a share plan and detail of how it works isn’t shared with UK employing subsidiaries – specialist advice might be required on how your plan actually works;
  • Is your statutory Corporation Tax relief correct? Net-settling awards reduces statutory Corporation Tax relief that would otherwise be available, so it’s important to identify net-settled awards to ensure that Corporation Tax relief is claimed on the correct basis;
  • Are any ‘general principles’ deductions in line with HMRC’s guidance? In the absence of any previous guidance, you might not have taken any ‘general principles’ deductions at all, or your filing position might not be in line with HMRC’s newly published views – it’s important to confirm this to determine whether any further action or changes to your approach are required;
  • Do you need to amend any relief you’ve claimed in the past? If you’ve net-settled or cash cancelled a share-based award but claimed statutory Corporation Tax relief for its full value, this should be amended, and relief claimed on the correct basis. Similarly, if how your employee share plan is structured and operates falls within the scope of HMRC’s new guidance, but in the past you’ve claimed a ‘general principles’ deduction for the cash cost of net-settling or cash cancelling awards on a different basis, you should review your historical filing position to confirm what amendments are required (note HMRC’s guidance states that any deductions that are ‘rolled up’ and taken in full in the year of settlement, or based on the entire accounting charge in the relevant year, will be challenged). Alternatively, if the structure of your employee share awards doesn’t fall within the scope of HMRC’s new guidance (e.g. if, like some RSUs, they are not ‘share options’ for Corporation Tax purposes), or HMRC have specifically agreed an alternative basis for Corporation Tax relief for the cash cost of net-settlement or cash cancellation in the past, you should review whether your historical filing position remains sustainable (for relevant companies, this should include considering whether HMRC should be notified of any ‘uncertain tax treatment').

If you would like to discuss how HMRC’s new guidance might impact your Corporation Tax position, or any aspect of your employee share plans, please contact the authors or your usual KPMG in the UK contact.