Global share plans: change ahead for UK employees?

The current tax treatment of non-UK company share ‘buybacks to cover’

Broadly, if the corporate law in the jurisdiction where a non-UK resident company is incorporated treats a purchase of own shares as a capital event (rather than as a distribution of income), a ‘buyback to cover’ should be within the scope of Capital Gains Tax (CGT) for UK resident employees.

This means that, provided the relevant shares are sold on the date on which the employee acquires them, for example on vesting of a Restricted Stock Unit (RSU), no CGT charges should arise because the proceeds received on sale should be equal to the cost basis in those shares (i.e. the amount taxed as employment income when the RSU vests).

What might change?

The Government proposes that the personal tax treatment of a buyback of non-UK resident company shares be brought into line with the tax treatment of a buyback of UK resident company shares.

If this is taken forward, the cash proceeds received on a ‘buyback to cover’ of non-UK resident company shares, less the capital originally subscribed for them on issue, would be subject to income tax at dividend rates in the employee’s hands. This would be in addition to the income tax due on the market value of the shares, when acquired, as employment income.

For example, if a higher rate taxpayer acquires 100 shares on the vesting of an RSU with a market value of GBP 10 each, they will be subject to employment income tax and employee’s social security at 47 percent on employment income of GBP 1,000 (GBP 470 in total).

If 50 shares worth GBP 500 in total are sold on the RSU’s vesting date under ‘buyback to cover’ arrangements, and the capital originally subscribed on issue of those shares was their nominal value of GBP 1 per share, the employee would then be subject to a further income tax charge on a distribution of GBP 450 (GBP 500 less GBP 50) at the higher dividend rate of 35.75 percent (GBP 161 when rounded up).

In this example, the employee would therefore pay total income tax and employee’s social security of GBP 631 on GBP 1,000 of value received from the RSU – an effective rate of 63.1 percent.

In contrast, under the current personal tax treatment of a ‘buyback to cover’ arrangement, the employee would expect to pay income tax and social security of GBP 470 on the market value of the shares acquired as employment income and no CGT on the subsequent ‘buyback to cover’ sale.

The above rules already apply to UK resident companies. For this reason, a UK resident company would typically use a ‘market sale to cover’ or have an employee benefit trust buy-back shares rather than buying back employee shares directly. However, use of employee benefit trusts by non-UK resident companies is much less common and may have other tax implications.

Introduction of an employee share scheme exemption?

Given that employee share ownership remains an important component of the UK’s growth agenda, in our view there is a strong argument for a targeted exemption from the relevant rules (regardless of whether the relevant company is UK or non-UK resident), where the shares that are being bought back were acquired pursuant to a bona fide employee share scheme.

We put this to the Government as part of our consultation response. However, responses to the consultation are currently under consideration by the Government, and it remains to be seen what approach it will take.

What should companies do now?

We do not yet know whether these proposals will be taken forward or in what form.

Companies should therefore monitor HMRC’s response to the consultation and any legislative developments closely, particularly where ‘buyback to cover’ is an important part of how they operate their employee share plans.

Some indication of the likely timescale for a full response to the representations made might be given in October’s Budget. In the meantime, companies should review their existing arrangements and consider the potential implications for the operation of the plan and employee communications.

Key points to consider include:

• Whether the group share plans use ‘buyback to cover’ arrangements: Ensure that all relevant teams within the group are clear as to the exact mechanics of recovering payroll withholding on employee share awards – whether ‘buyback to cover’, ‘market sale to cover’, or some other arrangement such as net-settlement (though whilst these arrangements in principle have different features, their names are not terms of art and may be used interchangeably to apply to a variety of arrangements in practice);
• Potential alternative arrangements: Model what impact these proposals could have, if brought forward, on existing arrangements for recovering payroll withholding on share awards. For example, if a company moves from using ‘buyback to cover’ to net-settlement arrangements to ensure no additional income tax charges for employees, this would reduce the specific UK statutory corporation tax deduction available in respect of the employee share acquisition, and a deduction for the cash cost of net-settlement would need to be taken on a general principles basis – which might result in a lower deduction; and
• Whether the tax treatment of current arrangements is correct: If ‘buyback to cover’ is used to hedge payroll withholding obligations, has the group confirmed that (1) the buyback is treated as a capital event under the appropriate overseas corporate law, and (2) employees’ shares are in fact sold on the date of acquisition (as if shares are sold on a later date, depending on individual employees’ personal circumstances, additional CGT charges might arise)?

How KPMG can help

We advise UK and non-UK companies on all aspects of the design and operation of employee share incentive arrangements, including in relation to the design and tax implications of mechanisms to recover payroll withholding. Please contact the authors or your usual KPMG contact to discuss what these issues could mean for your business.

For further information please contact:

• Alison Hughes
• Lorna Jordan