Some employees are eligible to receive shares in the company they work for under an Employee Share Scheme (ESS). It is helpful to understand what is likely to be taxed and when.
Some companies adopt ESS to incentivise their employees to work towards the success of the company as both an employee and as a potential shareholder. Because owning shares may benefit the employee financially, income tax may be payable.
What is taxed?
There are many forms of ESS. Some employees are given shares for free or at below market rate if they meet certain conditions. Others are given the opportunity to buy shares and pay them off through salary sacrifices.
In a nutshell, if as an employee receives a financial benefit from ESS, irrespective of how the shares were acquired, the taxable amount is the difference between the market value of the shares and what was paid for the rights. Note that some ESS are exempt from taxation.
Employers may tax ESS employee benefits, however, if they don’t, the employee will need to account for it themselves by filling out an IR3 form. Note that employees can retrospectively advise Inland Revenue of benefits from previous years by making a voluntary disclosure.
When does tax get calculated?
When it comes to ESS the point the employer holds the shares for the beneficial ownership of the employee is the vesting date. In straight forward ESS, the share scheme taxing date is when the employee exercises their option for the shares (takes up their right to the shares). This makes sense in situations where there is a risk that after the shares have vested, the employee might leave or otherwise forfeit their right to the shares. In those situations, it would not be fair to tax the employee at vesting date, because they might not ever exercise their option.
Recently however Inland Revenue released a Technical Decision Summary about a situation that was not a straight forward ESS. The employer had taxed the employee at the date the shares were exercised but the employee disputed this interpretation, arguing that the tax date should be when the shares vested.
The Tax Council Office in its adjudication found in this particular situation the share scheme taxing date was the date of vesting because that is the first date that the shares were held for the benefit of the employee and after which there was no material risk that their beneficial ownership of the shares would change, for example by the employee leaving. In this case there was no material risk that the employer would fail to exercise their option after the vesting date.
Key takeaway
If you make a financial return from an ESS you will likely need to pay tax. The date from which the tax applies will depend on the particular ESS and the employee’s circumstances. It might be at the date the employee exercises their rights or it might be at the date of vesting if there is no material risk that the employee will fail to realise their option.
Contact us if you would like to know more about ESS and whether this might be a good option for your company and employees.
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This article is general in nature and is not a substitute for legal advice. You should talk to a lawyer about your specific situation. Reproduction is permitted with prior approval and credit being given back to the source.
