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07 February 2001
Going … Going … Gone?
MARK SAUNDERS BEng, ATII, ACA discusses capping National Insurance contributions on share options.
MARK SAUNDERS BEng, ATII, ACA discusses capping National Insurance contributions on share options.
Going … Going … Gone?
MARK SAUNDERS BEng, ATII, ACA discusses capping National Insurance contributions on share options.
ONE OF THE things that I like best about January is shopping in the New Year sales. Every shop seems to have a giant sign telling you how fantastic its discounts are (over 75 per cent off in some cases!). Then, towards the middle of January, all the signs are taken down. The sales are over, and if you missed the bargain of a lifetime, it is hard luck. Or is it? Do you ever have a suspicion that the bargains were not quite as good as you first thought? I know I do.
The new National Insurance capping elections remind me of the January sales. The Social Security (Share Options) Bill is absolutely fantastic. Some employers will be able to take advantage of it to completely eliminate their National Insurance contributions liability on the share options that they have granted – how many shops give you 100 per cent off? Others will be able to pay a reduced amount or will be able to 'price match'. However, they will only have 60 days to do so. After that, the sale will end. Unlike shopping though, there will not be any more sales next year.
What is a capping election?
The new Bill allows employers to make an election in respect of share options that were granted between 6 April 1999 and 19 May 2000 inclusive. The effect of the election is to pretend that the options covered by the election were actually exercised on 7 November 2000. Fortunately, the pretence only extends to National Insurance contributions and not to income tax. When the election is made, the employer has to make a special National Insurance payment based on 12.2 per cent of the notional gain. But in many cases, the employer will not have to pay anything.
The capping elections can only be made in the 60 days starting with the date of Royal Assent. Unfortunately, it is too early to put a date in your diary, as no one knows when Royal Assent will be. A fair guess might be that it would be before the next general election. If this is indeed in May 2001 then the 60 days will end early in the summer.
This tight deadline is fraught with practical difficulties. If you are in private practice, do you know which of your clients have granted share options? Will you talk to them again between now and May? What happens if you do not mention capping elections?
Making an election
Capping elections can be made for options that will or may give rise to a Class 1 National Insurance contributions liability. This means that it will not be possible to make an election where there would be a Class 1A National Insurance liability, for example, the employee was resident but not ordinarily resident in the United Kingdom when the option was originally granted. Similarly, the elections only apply to options and not, for example, conditional shares.
The options covered by the election must have been granted between 6 April 1999 and 19 May 2000 inclusive. For options granted before 6 April 1999, there is no need for a capping election as no National Insurance should be due on the exercise of the option (with the exception of those options that will give rise to a Class 1A National Insurance liability when the shares acquired are sold). The new rules for transferring the National Insurance liability on options to the option-holders were announced19 May 2000. The Government has taken the view that from that date, employers had other ways of mitigating their National Insurance liability and so it is not necessary to allow those options to be capped.
Another requirement is that the option must not have been exercised before 8 November 2000, but more on this later. Special rules apply to options that have been rolled over since 19 May 2000 and also to options where some or all of the National Insurance liability has been transferred to the option-holder under paragraph 3B of Schedule 1 to the Social Security Contributions and Benefits Act 1992. Neither of these points is covered further in this article.
Employers can make the capping elections on an option-by-option basis. The format for the capping elections has not yet been announced. Regulations will set out the details that must be included on an election. It is to be hoped that the regulations will come out before the end of the 60-day period, although past performance would suggest that they will come out on day 50! The Inland Revenue's press release suggests that the elections will need to contain details of the option-holder's name and National Insurance number. It would be helpful if that requirement is relaxed so that employers can give a simple description of the options covered, for instance, all options granted on 1 March 2000, rather than have to supply reams of paper listing all of the options that they have granted.
What happens once the election is made?
Once a capping election is made, the option is deemed to have been exercised on 7 November 2000 and the gain, for National Insurance purposes only, is calculated on normal income tax principles. This is normally the difference between the amount that the shares might reasonably be expected to obtain on a sale in the open market and the exercise price. When calculating the open market value for listed shares, remember to use the bid price and make a deduction for the notional share selling costs.
A special contribution is normally due on this deemed gain. The rate of this special contribution is 12.2 per cent and it is due by the end of the 60-day period. If it is not paid at this time, the Revenue can deem that the election is invalid. If there is no gain on the deemed exercise, no special contribution will be due. This may occur, for example, where the option is underwater, i.e. the share price on 7 November 2000 is below the exercise price. Similarly, if the shares are not readily convertible assets on 7 November 2000, none will be due.
On the subsequent exercise of the option, no National Insurance is due (either primary or secondary). In addition, no refund of the special contribution will be made if the option is never exercised or if the gain on the actual exercise is less than on the deemed exercise. This means that there can be considerable uncertainty in making a capping election.
Options already exercised
The Government has also copied the 'price match' deal offered by some shops. Price match deals usually mean that the shopper will get some money back if he can find the same item for a lower price in the next seven days. A similar deal applies to share options but, like price match deals, conditions apply.
The option must not have been exercised before 8 November 2000. If it has, nothing can be done. If the option is exercised some time after 7 November 2000 and before the last day on which the capping elections can be made, the employer can, if it chooses, make a capping election. In this case though, it is a bit like being able to buy a lottery ticket after the winning numbers have been announced. If the National Insurance due on the actual exercise is less than that which would have been due on the deemed exercise, no capping election would be made. Conversely, if the National Insurance on the actual gain was more than that on the deemed gain, a capping election should be made.
For example, let us assume that an employer has paid National Insurance contributions of £1,000 on 19 January 2001 in respect of an option exercised in December 2000. If the employer would have paid National Insurance of £800 on a deemed exercise, then he should make the capping election and save £200.
Even though the Bill has not yet received Royal Assent, employers can assume that they will make a capping election when working out how much National Insurance is due. However, if they forget to make an election, the employer will be exposed to interest and a risk of penalties. There are fallback provisions so that if the Bill never receives Royal Assent, employers will have to pay any shortfall in National Insurance by January 2002.
The longer term
After looking at how incredible the new deal is, the doubts inevitably start to nag. You begin to wonder how a shop can offer 50 per cent off a product. Did it double the price before Christmas so that it can give you 50 per cent off in January? Was there any National Insurance on the exercise of share options before 6 April 1999? No.
Shopping around will allow you to avoid buying goods at hyped-up prices. But what can you do about National Insurance contributions on share options? The main solutions are: approved and enterprise management incentive option plans, passing the National Insurance to employees and hedging your liabilities.
Happy shopping …
Mark Saunders is a senior manager in Arthur Andersen's human capital practice, specialising in share plans. He can be contacted on 0118 952 3323 or via e-mail: mark.saunders@uk.arthurandersen.com.
The views expressed in this article are his own and do not necessarily reflect those of the firm.
Who would want to make a capping election?
For some employers, it will be obvious that they should make a capping election. For others, it will be a more complex decision. Where there is no National Insurance to pay on making the election, it would normally be sensible to do so, for example:
Approved share option plans: Normally, no National Insurance is due when an approved option is exercised. However, an approved plan can lose its approved status. For example, on a demerger a company may want to adjust the options to make the employee commercially whole. However, this cannot be done in an approved way. An employer may wish to make a protective capping election to ensure that the National Insurance liability on any subsequent exercise is either reduced or entirely eliminated (depending on the circumstances that give rise to the loss of approval).
Unlisted companies whose shares are not readily convertible assets on 7 November 2000: No National Insurance is payable on the deemed exercise of an option where the underlying shares are not 'readily convertible assets'. Unlisted shares will only be considered readily convertible assets if, broadly, arrangements exist or are likely to come into existence to enable cash to be realised from the shares.
Companies with underwater options on 7 November 2000: Where an option was underwater on 7 November 2000 there will be no gain on the deemed exercise and therefore no National Insurance liability if a capping election is made.
For options that do not fall into the above categories, careful consideration will need to be given as to whether an election should be made. Employers will normally need to take account of the following factors: future share price changes, option lapse rates, future National Insurance rates and the time value of money.
MARK SAUNDERS BEng, ATII, ACA discusses capping National Insurance contributions on share options.
ONE OF THE things that I like best about January is shopping in the New Year sales. Every shop seems to have a giant sign telling you how fantastic its discounts are (over 75 per cent off in some cases!). Then, towards the middle of January, all the signs are taken down. The sales are over, and if you missed the bargain of a lifetime, it is hard luck. Or is it? Do you ever have a suspicion that the bargains were not quite as good as you first thought? I know I do.
The new National Insurance capping elections remind me of the January sales. The Social Security (Share Options) Bill is absolutely fantastic. Some employers will be able to take advantage of it to completely eliminate their National Insurance contributions liability on the share options that they have granted – how many shops give you 100 per cent off? Others will be able to pay a reduced amount or will be able to 'price match'. However, they will only have 60 days to do so. After that, the sale will end. Unlike shopping though, there will not be any more sales next year.
What is a capping election?
The new Bill allows employers to make an election in respect of share options that were granted between 6 April 1999 and 19 May 2000 inclusive. The effect of the election is to pretend that the options covered by the election were actually exercised on 7 November 2000. Fortunately, the pretence only extends to National Insurance contributions and not to income tax. When the election is made, the employer has to make a special National Insurance payment based on 12.2 per cent of the notional gain. But in many cases, the employer will not have to pay anything.
The capping elections can only be made in the 60 days starting with the date of Royal Assent. Unfortunately, it is too early to put a date in your diary, as no one knows when Royal Assent will be. A fair guess might be that it would be before the next general election. If this is indeed in May 2001 then the 60 days will end early in the summer.
This tight deadline is fraught with practical difficulties. If you are in private practice, do you know which of your clients have granted share options? Will you talk to them again between now and May? What happens if you do not mention capping elections?
Making an election
Capping elections can be made for options that will or may give rise to a Class 1 National Insurance contributions liability. This means that it will not be possible to make an election where there would be a Class 1A National Insurance liability, for example, the employee was resident but not ordinarily resident in the United Kingdom when the option was originally granted. Similarly, the elections only apply to options and not, for example, conditional shares.
The options covered by the election must have been granted between 6 April 1999 and 19 May 2000 inclusive. For options granted before 6 April 1999, there is no need for a capping election as no National Insurance should be due on the exercise of the option (with the exception of those options that will give rise to a Class 1A National Insurance liability when the shares acquired are sold). The new rules for transferring the National Insurance liability on options to the option-holders were announced19 May 2000. The Government has taken the view that from that date, employers had other ways of mitigating their National Insurance liability and so it is not necessary to allow those options to be capped.
Another requirement is that the option must not have been exercised before 8 November 2000, but more on this later. Special rules apply to options that have been rolled over since 19 May 2000 and also to options where some or all of the National Insurance liability has been transferred to the option-holder under paragraph 3B of Schedule 1 to the Social Security Contributions and Benefits Act 1992. Neither of these points is covered further in this article.
Employers can make the capping elections on an option-by-option basis. The format for the capping elections has not yet been announced. Regulations will set out the details that must be included on an election. It is to be hoped that the regulations will come out before the end of the 60-day period, although past performance would suggest that they will come out on day 50! The Inland Revenue's press release suggests that the elections will need to contain details of the option-holder's name and National Insurance number. It would be helpful if that requirement is relaxed so that employers can give a simple description of the options covered, for instance, all options granted on 1 March 2000, rather than have to supply reams of paper listing all of the options that they have granted.
What happens once the election is made?
Once a capping election is made, the option is deemed to have been exercised on 7 November 2000 and the gain, for National Insurance purposes only, is calculated on normal income tax principles. This is normally the difference between the amount that the shares might reasonably be expected to obtain on a sale in the open market and the exercise price. When calculating the open market value for listed shares, remember to use the bid price and make a deduction for the notional share selling costs.
A special contribution is normally due on this deemed gain. The rate of this special contribution is 12.2 per cent and it is due by the end of the 60-day period. If it is not paid at this time, the Revenue can deem that the election is invalid. If there is no gain on the deemed exercise, no special contribution will be due. This may occur, for example, where the option is underwater, i.e. the share price on 7 November 2000 is below the exercise price. Similarly, if the shares are not readily convertible assets on 7 November 2000, none will be due.
On the subsequent exercise of the option, no National Insurance is due (either primary or secondary). In addition, no refund of the special contribution will be made if the option is never exercised or if the gain on the actual exercise is less than on the deemed exercise. This means that there can be considerable uncertainty in making a capping election.
Options already exercised
The Government has also copied the 'price match' deal offered by some shops. Price match deals usually mean that the shopper will get some money back if he can find the same item for a lower price in the next seven days. A similar deal applies to share options but, like price match deals, conditions apply.
The option must not have been exercised before 8 November 2000. If it has, nothing can be done. If the option is exercised some time after 7 November 2000 and before the last day on which the capping elections can be made, the employer can, if it chooses, make a capping election. In this case though, it is a bit like being able to buy a lottery ticket after the winning numbers have been announced. If the National Insurance due on the actual exercise is less than that which would have been due on the deemed exercise, no capping election would be made. Conversely, if the National Insurance on the actual gain was more than that on the deemed gain, a capping election should be made.
For example, let us assume that an employer has paid National Insurance contributions of £1,000 on 19 January 2001 in respect of an option exercised in December 2000. If the employer would have paid National Insurance of £800 on a deemed exercise, then he should make the capping election and save £200.
Even though the Bill has not yet received Royal Assent, employers can assume that they will make a capping election when working out how much National Insurance is due. However, if they forget to make an election, the employer will be exposed to interest and a risk of penalties. There are fallback provisions so that if the Bill never receives Royal Assent, employers will have to pay any shortfall in National Insurance by January 2002.
The longer term
After looking at how incredible the new deal is, the doubts inevitably start to nag. You begin to wonder how a shop can offer 50 per cent off a product. Did it double the price before Christmas so that it can give you 50 per cent off in January? Was there any National Insurance on the exercise of share options before 6 April 1999? No.
Shopping around will allow you to avoid buying goods at hyped-up prices. But what can you do about National Insurance contributions on share options? The main solutions are: approved and enterprise management incentive option plans, passing the National Insurance to employees and hedging your liabilities.
Happy shopping …
Mark Saunders is a senior manager in Arthur Andersen's human capital practice, specialising in share plans. He can be contacted on 0118 952 3323 or via e-mail: mark.saunders@uk.arthurandersen.com.
The views expressed in this article are his own and do not necessarily reflect those of the firm.
Who would want to make a capping election?
For some employers, it will be obvious that they should make a capping election. For others, it will be a more complex decision. Where there is no National Insurance to pay on making the election, it would normally be sensible to do so, for example:
Approved share option plans: Normally, no National Insurance is due when an approved option is exercised. However, an approved plan can lose its approved status. For example, on a demerger a company may want to adjust the options to make the employee commercially whole. However, this cannot be done in an approved way. An employer may wish to make a protective capping election to ensure that the National Insurance liability on any subsequent exercise is either reduced or entirely eliminated (depending on the circumstances that give rise to the loss of approval).
Unlisted companies whose shares are not readily convertible assets on 7 November 2000: No National Insurance is payable on the deemed exercise of an option where the underlying shares are not 'readily convertible assets'. Unlisted shares will only be considered readily convertible assets if, broadly, arrangements exist or are likely to come into existence to enable cash to be realised from the shares.
Companies with underwater options on 7 November 2000: Where an option was underwater on 7 November 2000 there will be no gain on the deemed exercise and therefore no National Insurance liability if a capping election is made.
For options that do not fall into the above categories, careful consideration will need to be given as to whether an election should be made. Employers will normally need to take account of the following factors: future share price changes, option lapse rates, future National Insurance rates and the time value of money.
