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Share option NIC regulations: Background Information

11th Oct 2000
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Under new legislation introduced in the Child Support, Pensions and Social Security Act 2000 the employer and employee will be able to make a joint election under which the liability for all or part of the employer's NICs on share option gains is transferred to the employee. These regulations provide the supporting legislation to enable employers to make elections. An election will take effect after the Inland Revenue have approved the form of the election and the arrangements made for securing that any liability transferred by the election is paid.

Approval to applications for elections can now be made after which employers and employees can make an election in relation to any unapproved share option granted on or after 6 April 1999 where the gain has not yet arisen. Additionally, employers may also make elections covering options granted to their employees where the share option gain is made after 19 May but before the election is made provided that the election is made by the 27 October 2000.

This change should help companies with very volatile share prices that offer their employees substantial share options as part of their remuneration package. Transferring the charge to the employee should solve the accounting difficulties faced by companies, particularly in the US. These arise because of the need for companies to put a provision in their accounts for a NICs liability that is unpredictable since it depends on the company's share price at the time when the employee decides to exercise his or her option. It also helps smaller start-up companies which may have limited cash flow by moving the liability for the employer's NICs charge to the employee.

Since 6 April 1999 National Insurance has been payable by both employer and employee on the gains arising when share options granted after 5 April 1999 are exercised outside an Inland Revenue approved scheme (or are cancelled or assigned) and where the shares or the option are readily convertible into cash. Before then, National Insurance was payable when share options were granted, but only if the options were granted at a discount and any charge was limited to the amount of this discount. The rules were changed because the charge at grant reflected neither the gain that the employee made when the option was exercised nor the fact that the option might not be exercised. The old rules were also deliberately used by some firms to pay large bonuses to directors and top-paid employees free of National Insurance.

Whereas the employee's earnings are subject to a cap (currently £27,820) above which no NICs are payable by the employee, the earnings cap on secondary NICs (normally borne by the employer) was removed in 1985 by the previous Administration to offset the cost of reducing the NICs burden for the lower paid. The secondary contribution rate is currently 12.2%.

There are currently two Inland Revenue approved share options schemes, the SAYE Sharesave scheme which is an all-employee scheme and the Company Share Option Plan (CSOP) under which an employee can be granted options over shares worth up to #30,000. Gains arising from the exercise of options under these schemes are free of income tax and National Insurance. In addition, the new Enterprise Management Incentives introduced in this year's Finance Act enables small higher-risk companies to grant up to £1.5 million of options free of tax and National Insurance to retain and recruit highly-skilled individuals.

Income tax is chargeable on gains made by employees from unapproved share options. The employer must account to the Inland Revenue for the tax under PAYE if the shares are readily convertible into cash. Where income tax on the gain is payable through PAYE a NIC liability will also arise.

Companies with very volatile share prices expressed concern that their exposure to an unpredictable NICs liability on unapproved share options could endanger their investment strategies and damage their future growth by deterring investors. The Chancellor announced in his Budget speech that he was asking the Financial Secretary to consult on a technical solution to this problem that would allow employer and employee to come to a voluntary agreement under which some or all of the employer's NICs liability would be paid by the employee. During that consultation many companies said that they would use the opportunity to recover the NICs charge from the employee. But those that reported in the US said they could not make such agreements because this would cause accounting difficulties. The election process was therefore developed as an alternative solution, in consultation with US companies, so that the liability could be transferred to the employee, if the employee agrees, in a manner that prevents the US accounting difficulties.

On 19 May it was announced that legislation would be introduced at the earliest opportunity to allow the employee to bear the employer's NIC on share option gains. It was also announced that the employer's NIC paid by employees as a result of this change would qualify for relief against the taxable gain on the share option. The primary legislation was contained in the Child Support, Pensions and Social Security Act 2000 and the Finance Act 2000, both of which received Royal Assent on the 28 July.

The amendments made are contained in The Social Security (Contributions)(Amendment No.10) Regulations 2000 (SI 2000/2744), The Social Security (Contributions)(Amendment No.10)(Northern Ireland) Regulations 2000 (SI 2000/2743) and consequential amendments in The Income Tax (Sub-contractors in the Construction Industry and Employments)(Amendment) Regulations 2000 (SI 2000/2742).

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