Finance Act 2013: changes to HMRC

Key changes Other changes Finance Act 2013: Action required changes to HMRC Summary The Finance Act 2013 (FA13) has made a number of amendments to the legislation regulating HMRC, ie the Sharesave (SAYE), the Share Incentive Plan (SIP) and the Company Share Option Plan (CSOP). Some of these amendments are important and require action, including: amending plan rules and supporting documentation to reflect changes made by the legislation; and formulating a policy on retirement. In the majority of cases share plans are updated automatically by FA13, which took effect on 17 July 2013. Companies should, however, amend their rules so that they accurately reflect the revised legislation. This briefing sets out the key changes made by FA13 and indicates which plans are affected. Key changes Removal of the requirement to include a specified age for retirement (affects SAYE, SIP and CSOP) Prior to FA13 companies were required to include a specified age for retirement in SAYE plans, SIPs and CSOPs. Companies needed to select an age within an age range (which differed according to the type of plan, being a minimum age of 50, 55 and 60 for SIP, CSOP and SAYE respectively). Your plan rules will state the specified age. From this age retirees are entitled to tax favoured treatment of their options and SIP awards. FA13 removes this requirement (although the specified age will remain relevant in one respect for SAYE, as discussed below). Although this may broaden good leaver status for participants, it will cause a headache for companies for the reasons explained below. Simon Evans T +44 7710 553 038 E simon.evans@freshfields.com Alice Greenwell T +44 7971 894 138 E alice.greenwell@freshfields.com Jocelyn Mitchell T +44 7710 606 914 E jocelyn.mitchell@freshfields.com Martin Macleod T +44 7590 738 200 E martin.macleod@freshfields.com Changes Removal of the specified age means that SAYE options will now become exercisable when a participant leaves employment on retirement irrespective of the participant s age. What retirement means is discussed below. Such an exercise will be tax favoured (ie no income tax will arise). The current specified age will have a continuing relevance for pre-july 2013 SAYE options, which may still be exercised when a participant reaches the plan s specified age without retiring. This right will not be available to any new SAYE options granted. Likewise, CSOP options will no longer be subject to an income tax charge if they are exercised (within three years after grant) after the participant leaves employment because of retirement, irrespective of the participant s age. Finance Act 2013: changes to HMRC 1

Finally, SIP shares will not be taxed if they are removed from the plan after the participant leaves employment on retirement, irrespective of the participant s age. Free and matching shares cannot be forfeitable in these circumstances (previously they could be forfeitable on retirement before the specified age). Prior to FA13 the good leaver status of retirees under was inherently age discriminatory. Commentary For the reasons explained below FA13 s removal of the specified age for SAYE, SIP and CSOP is counter-intuitive in light of legal risks on age discrimination, and will cause some problems for companies. Retirement has been a tricky area for companies since it became unlawful (in 2006) to discriminate against employees on grounds of age without either a specific legislative exception or an objective justification that is, by showing that the discrimination is a proportionate means of achieving a legitimate aim. Age discrimination concerns became more acute for employers following the abolition of the default retirement age (65) in 2011. Prior to FA13 the good leaver status of retirees under was inherently age discriminatory, because older retirees options were treated more favourably than those of younger leavers both in respect of the ability to exercise and with regard to tax. (Remember that age discrimination legislation protects the young from discrimination favouring the old as well as protecting the old from discrimination favouring the young.) The legislative requirement to include a specified age gave companies a partial safe-harbour from age discrimination risks (age discrimination is permitted if required by statute), and companies were generally able to objectively justify their choice of specified age within the required range. Following FA13 companies are put in a much more difficult position. With no statutory definition of retirement, and no ability to adopt a specified age under the previous legislation, there is no safe-harbour to rely on. Instead, companies must be able to justify any age discrimination objectively and so must develop their own policy on the meaning of retirement for approved plans. This is not straightforward, because leavers are likely to use age discrimination arguments to press companies to treat them as retirees and so be permitted to exercise and qualify for favourable tax treatment. As a result companies wishing to minimise the age discrimination risk may consider applying retirement broadly among leavers, by treating retirement as applying from a fairly low age (eg 50). This would have the potential benefit of more leavers being classified as retirees (and thus eligible to exercise and benefit from tax favoured treatment). Some companies may not consider this to be in shareholders interests as an appropriate use of equity for incentivisation purposes. But too liberal an interpretation of retiree may be subject to challenge by HMRC, who may consider that the company is over-egging the age discrimination risk and that leavers are being treated as retirees solely for the purpose of gaining tax advantages. HMRC are likely to query decisions to treat leavers as retirees solely for the purposes of the share plans where they are not retirees in other contexts. HMRC guidance has recently been published but it does not really assist in view of the difficult legal issues involved: HMRC do not provide examples of retirement, nor will they give rulings on the subject. They are, however, clear that the policy should not be applied on a discretionary basis (ie the policy should be applied consistently in relation to all participants). Companies find themselves, therefore, in a difficult position: they must develop a policy for retirees that strikes a balance between minimising the risks of unlawful age discrimination and challenge from HMRC. Broadly, there are two main ways to approach a retirement policy: a company may determine that all leavers over a certain age are retirees although careful consideration is needed to determine that age; or a company may set a suite of conditions, a certain number of which must be satisfied in order for a leaver to be treated as a retiree. A minimum age may be one of the conditions, but other conditions might include, for example, the employee s anticipated future employment plans. 2 Finance Act 2013: changes to HMRC

The age element of a retirement policy will vary from business to business, but examples of what a company may decide is appropriate include the following: carrying out an analysis of the workforce to establish the age at which employees have typically retired in recent years; retaining the pre-fa13 specified age (although this could cause inconsistencies between SAYEs, SIPs and CSOPs, as each of these plans had a different earliest age for the specified age ); or using an appropriate age from another context, eg the youngest age at which an employee may draw a pension (other than for ill health) under the company s relevant pension plan. Legislation permits this to be as early as 55 (or 50 for certain employees who have protected pension ages), but retirement before the employee s normal pension age (eg 60) will generally require employer consent. It will generally be inadvisable to use the age at which an employee can claim a state pension (currently ranging from 61 to 68, depending on age now and gender), as this would be very unattractive for employees, ie too few would get the benefit of retirement status. Companies should not delay in writing their policy on the meaning of retirement for these purposes. This will help them to demonstrate that there is an objective justification (ie a proportionate means of achieving a legitimate aim) for any potential age discrimination. For the same reason, they should also ensure that they document particular decisions regarding retirement. Participants leaving the parent group on a TUPE transfer/sale of a subsidiary out of the group (affects SAYE and CSOP) Prior to FA13, holders of SAYE and CSOP options had the ability to exercise on leaving employment either because of a TUPE transfer or because the participant s employing subsidiary was sold out of the group. But such exercise was not tax favoured. Following the changes made by FA13 SAYE and CSOP options exercised in these circumstances will be tax favoured. In practice, tax favoured treatment following TUPE transfers is just a clarification, because case law permitted TUPE leavers to be treated as redundant for the purposes of the share plans (following Chapman and Elkin v CPS Computer Group plc). Following the changes made by FA13 SAYE and CSOP options exercised in these circumstances will be tax favoured. Tax reliefs on a takeover of the Plc (affects SAYE, SIP and CSOP) FA13 extends tax relief to most cash takeovers (ie where the participant remains in employment but there is a cash takeover of the company whose shares are used for the plan) provided certain conditions are met. Prior to FA13 tax favoured exercise of an option would not have been available before the third anniversary of grant, and there was no tax favoured treatment on removal of SIP shares from the plan. There are some limitations to the FA13 regime, including requirements that: the participant must receive cash (and no other assets) in exchange for the shares. Tax favoured treatment will, therefore, be lost if the takeover offer includes shares in the offeror as all or part of the consideration; the proposal to option holders under the takeover offer does not include an ability for rollover; there must not have been any arrangements for the takeover in place or under consideration when the option/sip award was granted; and in the case of an option, tax avoidance was not one of the main purposes for the arrangements under which the option was either granted or exercised. Removal of the limit on dividend reinvestment (affects SIP only) Prior to FA13, dividend reinvestment under a SIP (which allowed participants to purchase tax favoured dividend shares with dividends accruing on their shares within the SIP) was limited to 1,500 per annum. This cap has been removed by FA13 so there is no longer a limit on dividend reinvestment for tax years from 2013/2014. Finance Act 2013: changes to HMRC 3

Companies are permitted to impose a cap (or a method for determining a cap) on dividend reinvestment. In practice, companies are unlikely to want to do this except in limited circumstances (such as when they need to impose a limit because of prospectus rules). Some companies use an accumulation period (typically a year), during which deductions made from salary roll-up are used to purchase partnership shares at the end of that period. Although FA13 automatically makes changes to SIP rules, free/partnership share agreements entered into by SIP participants are likely expressly to cap dividend reinvestment at 1,500 per annum (rather than by reference to any cap in the legislation from time to time). If this is the case, companies must expressly inform participants in order to remove the cap under existing free/partnership share agreements. New free/partnership share agreements must also reflect the removal of the limit. Removal of the prohibition on use of restricted shares (affects SAYE, SIP and CSOP) Prior to FA13 companies were prohibited from using restricted shares in an SAYE, SIP or CSOP (except in limited circumstances). FA13 removes this prohibition. This will be of most value to unlisted companies, but listed companies may also be able to make use of the increased flexibility. For example, a company may consider imposing a post-exercise holding period for shares acquired under CSOP or SAYE. Or it may make free or matching SIP shares subject to a longer forfeiture period than was permitted prior to FA13, or make good leavers free or matching SIP shares subject to forfeiture (although we would expect most companies to keep the SIP forfeiture period and terms in line with the tax regime, and keep the period at three years and allow good leavers to retain their shares). Note that companies are still prohibited from making partnership shares or dividend shares under a SIP subject to forfeiture. Valuation of partnership shares (affects SIP only) Some companies use an accumulation period (typically a year), during which deductions made from salary roll-up are used to purchase partnership shares at the end of that period. Prior to FA13 companies had to determine the number of partnership shares to be awarded at the end of an accumulation period by reference to the lower of the market value of the shares at the beginning of the accumulation period and at the end of the period, when the partnership shares are actually purchased. This did not allow companies to hedge their cost exposures. Following FA13 companies may choose to use the value at the beginning or the end of the accumulation period, or the lower of the two. In principle this change may make accumulation periods more attractive, as companies can now create certainty as to the cost of acquiring the shares and can hedge that cost exposure if they wish to do so. In practice companies that currently operate SIPs with monthly purchases are likely to continue to do so, as employees are likely to be distrustful of deductions being made from salary when shares are not bought straightaway. Companies must inform participants which of the three valuation methods has been chosen. This must be set out in the partnership share agreement, meaning that any future partnership share agreement must be updated accordingly. Other changes In addition, there are some amendments of a more technical nature, which generally offer greater flexibility to companies. The changes are generally incorporated automatically into plan rules by FA13, but companies should still update their rules. The prohibition on SAYE and SIP participants having a material interest (ie broadly a 25 per cent shareholding interest) in a close company has been abolished. Employees with such a major shareholding may now participate in an SAYE or SIP on the same terms as any other employee. The material interest rules have also been revised for CSOP, so that options may be granted to employees who have beneficial ownership of, or the ability to control, up to 30 per cent of a company s share capital. This has been increased from 25 per cent. 4 Antitrust damage claims and collective actions in Europe June 2013

FA13 makes amendments to the terminology and legislative references describing the ways in which the listed company may be taken over, eg whether pursuant to a general offer, scheme of arrangement, etc.. Although these changes will not affect the day-to-day operation of a share plan, they are likely to be important if there is a takeover of Plc. The seven-year savings contract that was previously available under SAYE has been abolished. Companies may now use only three- or five-year savings contracts. As a housekeeping exercise, references to seven-year savings contracts should be removed from the plan rules. This may be an appropriate time to carry out a more general health-check on plan rules. Action required Companies need to take the following action: determine their policy for retirees. As discussed in paragraph 1 above, companies need to develop a policy for retirees that strikes a balance between minimising the risks of unlawful age discrimination and challenge from HMRC; amend their share plan rules so that they accurately reflect changes made by FA13. The majority of changes are made automatically by FA13, but any new documents need to reflect the updates (for example, future free share agreements under a SIP see paragraph 4 above). These amendments can generally be made by the board without the need for shareholder approval. This is because most rules specify that where amendments are to take advantage of any changes in legislation or to maintain or obtain favourable tax treatment, shareholder approval is not required (even if the amendments are in favour of participants); review any tax communications to participants to ensure they accurately reflect revisions to the tax treatment in relevant circumstances; and this may be an appropriate time to carry out a more general health-check on plan rules. For more information please contact: Simon Evans T +44 7710 553 038 E simon.evans@freshfields.com Jocelyn Mitchell T +44 7710 606 914 E jocelyn.mitchell@freshfields.com Alice Greenwell T +44 7971 894 138 E alice.greenwell@freshfields.com Martin Macleod T +44 7590 738 200 E martin.macleod@freshfields.com freshfields.com is a limited liability partnership registered in England and Wales with registered number OC334789. It is authorised and regulated by the Solicitors Regulation Authority. For regulatory information please refer to www.freshfields.com/support/legalnotice. Any reference to a partner means a member, or a consultant or employee with equivalent standing and qualifications, of or any of its affiliated firms or entities. This material is for general information only and is not intended to provide legal advice.,, 36894