PAYE, NIC and employee shares – private company challenges

The payroll treatment of employee shares in private companies can be complex – here’s what you should consider to be compliant

Are you operating PAYE correctly on shares?

Every year, HMRC check some employers’ payroll records to ensure they’re meeting their PAYE, NIC and – where relevant – Apprenticeship Levy obligations. Given their complex tax treatment, employee share plans and other arrangements involving employment-related securities (ERS) often give rise to compliance errors, particularly with private companies. This is because unlisted shares are more likely to fall within the scope of one or more of the ERS income tax charging provisions. Whether payroll withholding or self-assessment applies may also be unclear. ERS payroll errors are often highlighted by the employment-related securities returns that employers must submit to HMRC each year, and which ask for confirmation of whether PAYE/NIC were operated. ERS payroll compliance errors are also often detected by due diligence during a transaction and can potentially reduce the price achieved. This article looks at what employers should consider to ensure they can demonstrate to HMRC that their payroll withholding obligations in respect of ERS are being met.

When payroll withholding applies to ERS

Broadly, when an amount counts as employment income in connection with ERS, PAYE and employee’s NIC withholding obligations; and employer’s NIC and, where relevant, Apprenticeship Levy charges; arise for the employer if the securities are Readily Convertible Assets (RCAs) at that time. 

In summary, shares are RCAs if they are listed on a stock exchange or if, when they are acquired, other ‘trading arrangements’ exist which would enable them to be converted into cash. This would be the case where, for example, an internal market operates in an unlisted company’s shares (e.g. where the trustees of an Employee Benefit Trust or other shareholder(s) are prepared to purchase any shares offered for sale), or arrangements exist for unlisted shares to be repurchased by the issuing company.

Shares are also RCAs if such trading arrangements are likely to come into existence in accordance with an understanding or arrangement in place when they are acquired. Examples of this include where arrangements are being made for an IPO or sale of the company and the event is likely to go ahead (e.g. where the company has taken meaningful steps towards a flotation by instructing advisers).

Even where no trading arrangements exist, or are likely to come into existence, shares will be deemed to be RCAs if they are not ‘corporation tax deductible’. This includes where the shares are:

  • Issued by an unlisted company which is under the control of another unlisted company;
  • Not fully paid-up, non-redeemable, ordinary shares; or
  • Deemed to be employment-related, rather than as a matter of fact acquired by reason of employment (see a discussion of this issue in our articles on the Vermilion case and its potential relevance to family companies). 

It is necessary to consider whether shares are RCAs every time an employment income tax charge arises in connection with them, as the relevant facts and circumstances may have changed.

Securities that are not shares (e.g. loan notes) will always be deemed to be RCAs.

Operating payroll withholding – what’s required?

If shares or other securities are RCAs or deemed RCAs when an employment income tax charges arises in connection with them, the employer must account to HMRC for the relevant PAYE, NIC and – where relevant – Apprenticeship Levy. The employee must, within 90 days of the end of the tax year, ‘make good’ to their employer any PAYE relating to ERS to avoid additional ‘tax on tax’ charges arising. 

Some areas can present difficulties for employers when operating payroll in respect of ERS, including:

  • Leavers/former employees – payroll withholding is still required where an employee has left employment at the date of the taxable event, though depending on the circumstances this might be based on different rates and bands to when they were employed;
  • Operating payroll in the correct tax year – taxable amounts should be processed in the correct tax year (e.g. shares acquired for less than market value on 1 April 2024 should go through payroll for the 2023/24 tax year). This can be difficult where the normal monthly payroll has already been processed and it will often be necessary to run an additional payroll to ensure that the gains are processed in the right tax year; and
  • Internationally mobile employees – payroll calculations for internationally mobile employees can be complex, as it is necessary to establish how much of the amount that counts as employment income is liable to UK withholding, and there can be trailing liabilities for employees who have left the UK. Processes need to be in place to ensure that this is tracked and UK PAYE/NIC correctly operated where the relevant securities are RCAs. 

What should employers do?

Employers should review their payroll arrangements in respect of ERS to ensure that they are being treated correctly. Getting it wrong can lead to interest and penalties, and potentially to a wider HMRC compliance review.

Key questions to ask include whether you could demonstrate to HMRC that:

  • You are clear on when and in what circumstances amounts could count as employment income in connection with ERS (e.g. when restrictions lift, or rights are amended) and that you monitor this appropriately;
  • You monitor the RCA status of your company’s shares and other securities (including being clear on whether they are deemed RCAs);
  • You have a process in place to capture all relevant leavers and deal with their ERS awards correctly;
  • PAYE and NIC are operated correctly for internationally mobile employees, including employees on secondment to the UK or otherwise with taxable UK workdays;
  • Employment income tax charges are processed through payroll in the correct tax year (e.g., where income tax charges arise towards the end of the tax year);
  • Employees ‘make good’ any PAYE on ERS within 90 days of the end of the relevant tax year to prevent additional tax charges arising; and
  • Your payroll withholding reconciles with your annual ERS reporting (HMRC can compare payroll data and ERS annual returns to identify potential payroll withholding errors).

How KPMG can help

KPMG in the UK works with employers across all sectors to ensure their employment tax compliance is robust. We can review share plans and confirm the correct UK tax and payroll processes and assist with disclosing and correcting any errors.

If you would like to talk through how KPMG can support you with this, please get in touch with the authors of this article or your usual KPMG in the UK contact.