THE FINANCE ACT 2008 (THE ACT) HAS INTRODUCED substantial changes to the taxation of equity awards granted to internationally mobile employees (IMEs). The purpose of the changes is to align the taxation of employees who are resident but not ordinarily resident in the UK (RNOR) with employees who are resident and ordinarily resident in the UK (ROR). In addition, the Act introduces new provisions regarding the taxation of equity awards held by employees claiming the remittance basis of taxation.
The new rules only apply to grants of awards made on or after 6 April 2008, meaning that both regimes will need to be considered when assessing the UK tax implications of the grant, vesting or exercise of equity awards. This update focuses on employees who are either ROR or RNOR in the UK at the time of grant. Employees who are neither ROR nor RNOR at the time of grant will generally not be subject to UK tax unless the awards are specifically granted in respect of employment services to be carried out in the UK.
TAXATION OF EQUITY AWARDS GRANTED PRIOR TO 6 APRIL 2008
Employees who are ROR at the time of grant
Employees who are ROR at the date of grant are taxed on exercise or vesting of awards, rather than on grant. The exception to this rule is where an employee acquires shares in a company at a discount by reason of their employment, in which case there will be an immediate charge to tax.
The full amount of the gain is taxed in the UK on exercise or vesting if the employee is resident in the UK at that time. Generally, even if the employee has carried out employment services abroad, the gain will only be taxed in the UK provided that the employee is not resident in a foreign jurisdiction at the time of vesting or exercise of the award.
If the employee moves abroad and their award vests or is exercised while abroad, they may also be subject to tax in that foreign jurisdiction, in which case the employee may be entitled to relief under an applicable double-tax treaty or unilateral relief under UK law. In these circumstances, the effect of the relief is that the amount of the gain chargeable in each jurisdiction will be apportioned on a time basis.
Employees who are RNOR at the time of grant
An employee will generally be considered to be RNOR at the time of grant if they are resident in the UK but have not been resident in the UK or do not intend to be resident in the UK for three or more years.
With share options, restricted stock units or stock settled stock appreciation rights, a UK tax charge may arise in the following three circumstances where an equity award is granted to an RNOR employee:
- at the time of the award, if the amount the employee is required to pay to exercise the award is less than the market value of the underlying securities;
- at the time of exercise of the award, the amount of the gain is treated as a notional loan from the employing company, the individual being taxed on the notional interest treated as paid on the loan; and
- when the underlying shares are disposed of, the charge being equal to the full amount of the gain between grant and exercise.
If employees subsequently leave the UK and exercise their awards in a tax year following their departure, both the charge on notional interest and on disposal of the shares may not apply. However, care must be taken when relying on this exemption, as the split-year treatment provided for in ESC A11 does not apply in the year of departure in relation to the second and third charges set out above.
When dealing with restricted securities (for example, shares held by employees that are subject to forfeiture provisions on the cessation of employment), a UK tax charge will only arise on the initial acquisition of the shares if the shares are acquired at a discount to their market value at the time of the award. Unlike employees who are ROR, there will not be a further UK tax charge on either the lifting of restrictions or disposal of the shares.
TAXATION OF EQUITY AWARDS ON OR AFTER 6 APRIL 2008
Employees who are RNOR at the date of grant of equity awards will be taxed on the same basis as employees who are ROR for all grants on or after 6 April 2008. This will mean that employees who are RNOR at the date of grant will be subject to UK tax on exercise as opposed to at the time of grant. In addition, the notional loan provisions will no longer apply.
As with employees who are ROR, employees who are RNOR at the date of grant will be subject to UK tax even after they leave the UK, subject to relief under an applicable double-tax treaty or unilateral relief under UK domestic law.
EQUITY AWARDS AND THE REMITTANCE BASIS OF TAXATION
Employees who are either RNOR or ROR but not domiciled in the UK may be entitled to exemption from UK income tax if some of the gain on exercise or vesting of the award is attributable to employment services performed outside the UK. This exemption will be lost if the income from the award is brought back into the UK (which includes paying off UK debts). However, in circumstances where a UK tax charge arises, the employee will be required to account for the tax through their self-assessment return, rather than the employing company being required to account for the tax through PAYE.
It is hoped that in time the new rules will simplify the taxation of IMEs who are granted equity awards. However, the new rules will mean that companies need to consider two sets of rules when assessing the tax consequences of employees who are granted equity awards, as the old rules continue to apply to grants made prior to 6 April 2008.
In addition, companies will need to verify the residence of their employees at the date of grant and exercise or vesting of awards to assess whether any withholding obligations have arisen under PAYE, and assess whether any employees intend to claim the remittance basis of taxation.
By Anthony Whall, associate, Jones Day. E-mail: awhall@jonesday.com.