Disguised Remuneration - Pinsent Masons

Update
January 2011
Employee Taxation
Disguised Remuneration – the proposed new UK legislation and specifically
how the new rules may impact employee incentives
Draft legislation was published in the UK on 9 December 2010, setting out anti avoidance
measures to tackle arrangements using trusts or other vehicles to reward employees. The
arrangements will be introduced with effect from 6 April 2011, with anti-forestalling provisions
applying from 9 December 2010 up to that date.
The effect of the provisions will be to trigger an income tax charge when a third party (such as a
trustee) makes provision for what is in substance a reward or recognition or loan in connection
with the employee’s employment.
In this update we have set out the basic charging regime and some of the issues that may arise.
Whilst it is helpful that HMRC has confirmed it is not the intention to interfere with the operation
of ordinary share plans operated on a commercial basis with no tax avoidance motive it will be
necessary to follow the progress of this draft legislation to see how HMRC deals with this and the
many other areas that it is thought there was no intention to catch but which are currently not
excluded.
Background
It was announced in the March and June Budgets that the UK
Government would be reviewing arrangements using trusts
and other vehicles, which were intended to avoid or defer
income tax (and national insurance contributions (NICs)) on
employee remuneration. That review was not itself subject to
a consultation process, and therefore there has been no
formal engagement with taxpayers to date in relation to the
operation of the proposed new rules. The draft legislation on
"disguised remuneration" was published on 9 December 2010
and is now subject to consultation however, with the closing
date for comment on 9 February 2011.
The legislation will apply in respect of any employees who are
within the scope of UK income tax on relevant employment
income.
The legislation is intended to prevent the use of
arrangements such as remuneration trusts and employerfinanced
retirement benefit schemes (EFRBS) to provide
benefits with tax advantages, particularly to high earners.
Very broadly, EFRBS are a type of employee benefit trust
(usually situated offshore, allowing tax free 'roll-up' of
income and gains) which are set-up and funded by a UK
resident employer. Funds are then invested by the trustees to
be used to provide pensions or other benefits to the relevant
employees in the future.
Outline of the new rules
The draft legislation has deliberately been drafted to start
with a very wide net and then to exclude by specific
provisions. For example, it would catch HMRC-approved
share plans and registered pensions but for the specific
wording which excludes these. There is no general exclusion
for arrangements which are purely commercial and have no
tax avoidance motive. During the consultation process it is
therefore going to be necessary to review the drafting in
detail and to make representations to HMRC for all the
necessary exclusions.
The draft legislation provides for an income tax charge (which
must be accounted for by the employer and the equivalent
amount recovered from the employee under the "pay as you
earn" system (PAYE)) to arise broadly where there are
arrangements, using a trust or other vehicle, which will result
in a benefit to an employee as reward or recognition in
connection with employment. This will apply in the
following circumstances:
continued on next page

• where a sum of money or an asset, held by a trust or
other intermediary, is "earmarked" (however informally)
for use as part of the arrangements. The amount of
money or value of the asset will be treated as a payment
of income by the employer to the employee for PAYE
purposes. (Note the obligation to account for PAYE
remains with the employer even though the
trust/intermediary takes the relevant step in the
arrangements);
• where a trust/intermediary makes a payment, transfers
an asset, takes a step whereby shares/securities or share
options are acquired, provides a loan or grants a lease to
an employee, the amount paid, or market value of the
asset transferred or acquired will be treated as a payment
of income by the employer to the employee for PAYE
purposes. Note in relation to a loan that the full capital
value of the loan, not just the amount of the benefit, will
be subject to tax;
• if an asset is "made available" to an employee by a
trust/intermediary, for the employee to benefit from or
use as if his own, then again, the value of the asset will be
treated as a payment of income by the employer to the
employee for PAYE purposes.
Provisions will be introduced to apply NICs to these amounts.
There are particular provisions in relation to tax residence and
the remittance basis, which are not covered in this update.
What does this mean for share plans?
In relation to employee share plans, there are a number of
specific exemptions - however, the draft legislation is very
widely drafted and, as it currently stands, would potentially
affect certain commonly used share plan arrangements where
an employee trust is involved. It is common for UK listed
companies to source shares for their plans through market
purchase by an employee trust. HMRC has now confirmed
that the new rules should not catch this type of arrangement,
and further published guidance is awaited.
Exemptions
There are specific exemptions for any step taken under an
HMRC-approved share plan (Company Share Option Plan,
Share Incentive Plan or Sharesave) or an arrangement to grant
options as Enterprise Management Incentives.
There are also specific exemptions for the acquisition of
forfeitable shares or the grant of share options. In addition,
where an income tax charge arises on the lifting of
restrictions, for instance, when shares cease to be subject to
forfeiture, or on the exercise of a share option, the new rules
will not apply.
Concerns
The draft legislation is very widely drafted and as it currently
stands appears to catch arrangements which do not have tax
avoidance as part of their aim – in other words, it catches
more than just "disguised" remuneration, and extends to
other remuneration which is always intended to be fully
taxable. So where a trust or other intermediary is involved in
the operation of a share plan arrangement, such as an LTIP or
deferred bonus plan, then at present, it seems the new rules
may potentially apply.
For example, as noted above, UK companies commonly fund
employee trusts to acquire shares in the market and the trust
agrees to use those shares to satisfy awards at maturity. In
such circumstances, it is always intended that the employee
will be subject to income tax and NICs on maturity of the
awards. However, the legislation as currently drafted, may
impose a tax charge on awardholders when shares are
acquired, or "earmarked" by the trust – notwithstanding that
there may be conditions attached to the subsequent transfer
of those shares by the trust to the awardholder.
This is unintended - there could be an up-front tax charge
when a share plan award (of whatever type, and whether or
not subject to performance conditions) is made, just because
the shares are to be sourced via an employee trust, in
circumstances where there would not be such a charge if the
company planned to satisfy the awards directly by issuing
new shares.
This would often impact upon arrangements for the deferral
of bonus awards into shares – and this seems at odds with the
corporate governance pressures to defer bonuses into shares
and subject them to clawback conditions or "performance
adjustment".
Will this change?
We understand that HMRC is planning to publish further
guidance on the intended scope of the new rules, and hope
that this will clarify the extent to which the "normal"
operation of equity incentive arrangements will be affected.
What does this mean for general employee
taxation?
Areas currently caught (but which it is believed are likely to be
excluded ultimately) include many straightforward share plan
arrangements (see previous section), arrangements to defer
cash bonuses for regulatory reasons, arrangements put in
place to protect employees from the insolvency of their
employer and some overseas pension plans.

New arrangements
For those employers considering any new remuneration
arrangement involving a trust (or any other third party holding
shares or cash or providing some benefit to staff) it would be
sensible to consider whether to delay implementing such
arrangements until the position is clearer. This will include all
employers seeking arrangements (including EFRBS) to top up
(over the new £50,000 annual allowance from 6 April) or work
alongside registered pensions.
Existing arrangements
For those employers with an existing EFRBS or cash funded
employee benefit trust - it would be best to take no new steps
(so no new sub funds should be created or informal
allocations made and no new loans made) until the position is
clearer, including on the anti-forestalling rules. It seems that
any new step under existing arrangements may be a "relevant
step" for the purposes of the new rules. This includes where
steps have already been taken, such as loans being made, or
assets being made available.
Where existing arrangements will fall foul of the new rules (as
they ultimately are drafted), it may be possible to unwind
these in certain circumstances without adverse consequences
under the anti-forestalling rules. However, employers should
not act in haste until the final form of the legislation becomes
clearer.
What should employers be doing?
Employers using trusts in the operation and administration of
share plan and other remuneration arrangements need to be
aware of these new rules and their potential impact.
Before the new rules take effect on 6 April, anti-forestalling
rules may have effect, for example if shares are earmarked
(after 9 December) within a trust for use to satisfy particular
share awards. Note that if a charge arises between 9
December 2010 and before 6 April under the anti-forestalling
rules, this becomes due for payment on 6 April 2012.
However, in straightforward situations where there is no tax
avoidance intention, the current message is to "watch this
space" – on the basis that HMRC did not intend to catch
these situations, we hope there may be further exclusions or
clarification in this area.
Next steps
The draft legislation is subject to consultation before it is
introduced in Finance Bill 2011 in March and is likely to
change between now and then in response to representations
made. As mentioned above, HMRC is aware that there are
some unintended consequences of the draft legislation, and
will be producing further guidance to assist with companies'
concerns. In the meantime, if you have any particular
concerns or queries, please speak to your usual Pinsent
Masons contact, or to one of the team mentioned below.
Who to Contact
John Christian
Partner
DDI: 0113 294 5296
M: 07831 788196
E: john.christian@pinsentmasons.com
Rory Cray
Partner
Judith Greaves
Partner
DDI: 0113 294 5232
M: 07767 224098
E: judith.greaves@pinsentmasons.com
Lynette Jacobs
Partner
Janet Hoskin
Partner
DDI: 0113 294 5224
M: 07774 957985
E: janet.hoskin@pinsentmasons.com
DDI: 0113 294 5179
M: 07881 517922
E: rory.cray@pinsentmasons.com
DDI: 0161 250 0198
M: 07717 488467
E: lynette.jacobs@pinsentmasons.com
© Pinsent Masons LLP 2011
This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered.
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