Another Revenue-Induced Headache

Another Revenue-Induced Headache

MARTIN RILEY explains what a form 42 is and why, contrary to the Revenue's view, it might not be needed in the case of most incorporations.

WHEN I FIRST read about the new requirement to submit form 42 (a sixteen-page return!) before 7 July and that this applied to almost every company incorporated in the 2003-04 tax year, I felt that it was just a case of scaremongering. I suggested to other practitioners that if the legislation was really that wide then the Revenue would issue a news release very shortly to say that in the case of a 'normal' incorporation there would be no need to submit the form. How naïve I was! The Inland Revenue has now confirmed that it does require these details — even where companies are bought 'off the shelf' (i.e. where individuals become shareholders and then subsequently become directors and employees of those companies). Details need to be sent to Room 76 of Somerset House — all I can say is that Room 76 must be a very big room! There were 322,000 new incorporations in 2002-03 and who knows what this figure might be in 2003-04.

This article questions whether there is a reporting requirement in the first place, puts forward the case for a concession, and asks whether the Revenue has lost all respect for the professions.

Where has form 42 come from?

Good question! The simple answer to this is that it was introduced as part of the dreaded Schedule 22 to the Finance Act 2003 (entitled 'Employee Securities and Options') — which we all thought only applied to share schemes. If an employer gives shares to a key employee by reason of his employment, then this is the form on which that award of shares must be reported. It is quite acceptable that the Inland Revenue needs to know about this as it is clearly a taxable benefit — previously the reporting requirement was found in section 85(1), Finance Act 1988. However, it was always accepted that shares issued on formation of a company were not 'by reason of the employment' in most cases. (See the Inland Revenue's Inspector's Manual at paragraph IM5329 — which was replaced by Share Schemes Manual at paragraph SSM4.4.) It seems that paragraph SSM4.4 has not been updated to take Finance Act 2003 into account and the Inland Revenue considers that where shares are issued on the formation of a company and the shareholder then becomes a director and employee, then form 42 needs to be completed.

It should be stressed that the transfer of two subscriber shares from the founder shareholders to a prospective employee is considered to be a reportable event as is the subsequent issue of, say, a further 98 ordinary shares to prospective employees (even where there are no other assets owned by the company at that time).

Why do we need to report? Well, that's another good question. The Inland Revenue admits that in most cases no income tax liability will arise. It is beyond the scope of this article to explain when a tax liability might arise — but, basically, it is where you do 'something clever' with the shares to make them increase in value. I would suggest that in 99 per cent of cases where a new business is set up or an existing sole trader business is incorporated, then no income tax liability will arise.

What is the Inland Revenue trying to achieve?

There have been a number of schemes whereby cash bonuses have been paid to directors and employees — the Revenue calls it 'cash bonus planning' and its news release on 18 June 2004 suggests that £300 million of income tax and National Insurance contributions have been avoided in this way. The Revenue is keen to identify these and this is why the reporting requirements have been drafted so widely.

Most readers no doubt accept that the Revenue will want to prevent this type of tax avoidance but, as is so often the case nowadays, insufficient thought has been given to the drafting of the legislation and innocent transactions are being caught in the crossfire.

Reporting formalities and deadline

In most cases the form should be completed by 7 July after the end of each tax year (even where no form has been issued) for shares which have been issued or transferred to employees during the tax year. However, it was announced on 22 June that the statutory deadline of 7 July would — except as noted below — be extended this year by two months to 7 September, which at least allows practitioners to deal with P11D reporting and then concentrate later on forms 42. The reason for the extension is due to the fact that some practitioners have been unable to print off the form from the Revenue's website.

If, however, the form has been issued, then there is no extension granted — the form must be returned by the later of:

• 7 July 2004; and

• 30 days after the date of issue.

In fairness, the form should not be too difficult to complete. In most cases, details only need to be entered in section 2a and the form needs to be signed by the company secretary or acting secretary. The details required are:

• the name of employee and National Insurance number;

• the employing company and pay-as-you-earn reference number;

• a description of the securities;

• the date that the securities were acquired;

• the number of securities;

• the market value of the securities when acquired;

• the price (if any) paid by employee; and

• whether tax and National Insurance have been deducted under the pay-as-you-earn system.

Some 'frequently asked questions' have appeared on the Inland Revenue website which give practical guidance on completing forms 42; however, the point is that in most cases it is outrageous that we should have to waste our time — and clients' money — completing these forms when the Inland Revenue itself admits that, in the vast majority of cases, there will be no tax liability arising.

Do we actually need to report?

Looking more closely at the legislation I wonder whether we need to report in the first place.

The reporting requirements are set out in sections 421J to 421L, Income Tax (Earnings and Pensions) Act 2003 and one of the reportable events in section 421K(3) is:

'an acquisition ... of securities … pursuant to a right or opportunity available by reason of the employment of the person who acquires the securities ...'

It should be noted that 'securities' includes 'shares in any body corporate' (see section 420(1), Income Tax (Earnings and Pensions) Act 2003) and that, for the purpose of section 421K, 'employment' includes a former employment or prospective employment (see section 421B(2)). This is, therefore, why the Inland Revenue believes that the issue of shares on incorporation needs to be reported.

I am no barrister, but I would question whether the Inland Revenue interpretation is correct. The legislation states that the acquisition must be pursuant to an opportunity available by reason of the (prospective) employment. Surely this suggests that the employment must come before the opportunity to acquire the shares. But when an individual acquires a company 'off the shelf' then the shares are transferred to the individual from the company formation agents, the individual is then appointed director and then commences an employment with the company. How can the acquisition of shares be pursuant to something which does not yet exist? Indeed, I have a client where, for commercial reasons, the employment has never actually materialised and is now unlikely to do so.

When I first read section 421K, I expected to see words like 'scheme' or 'arrangement' or 'connected with' — so that where the various steps are pre-conceived (which they invariably are in the case of a 'normal' incorporation) then the reporting requirements would apply. Clearly, these are not the words used in the legislation — so is this all a lot of fuss over nothing?

Why should there be a concession?

Given that possibly 99 per cent of the incorporations in 2003-04 will be 'normal' incorporations where there will be no income tax liability arising, I spoke to an Inland Revenue official at Share Schemes Division and suggested that there should be a concession or something similar to paragraph SSM4.4 (referred to earlier). I suggested a concession for companies which issue shares to shareholders where the shares will only benefit from normal commercial growth to which only capital gains tax (and not income tax) may be applied.

I also made the following suggestions:

• In most cases, details of shareholdings held by directors are disclosed in the accounts, so the details could be disclosed as part of the CT600 — perhaps a supplementary page which can be submitted as an alternative to form 42. It was considered that this would be too late after the end of the tax year in some cases.

• Why not have a 'tick' box on the form P35 asking the directors if, to their knowledge, there were any shares transferred in the tax year to any employees or directors in circumstances where some form of benefit or value is or will be passed through their ownership of the shares over and above normal commercial growth? The Revenue could then issue forms 42 more selectively to businesses which tick the 'yes' box. This idea was considered to have some merit and so maybe we can look forward to this possibly being introduced next year.

Comments made by the Revenue

The following comments made by the Revenue show little understanding of the burden now placed on taxpayers and agents.

The first comment was that 'the obligations are not unduly onerous'. This was a comment made to me personally, but my reply was: 'try telling that to the thousands of practitioners around the country who have to complete the return and then get it signed by the company's secretary or acting secretary!' As mentioned, I accept that in most cases the only details required are those in section 2a of the return, but the instructions to this section still contain information about unrestricted securities and convertible securities. This must be extremely daunting to a client who has merely incorporated his corner-shop business.

Secondly, 'the obligation to report was well publicised on the Revenue website and in Share Focus'. The obligation to report has not been well publicised at all — none of the Inland Revenue representatives (including an Area Director) at my recent Working Together meeting was aware of it. Very few tax practitioners (let alone accountants) would normally read Share Focus ('the Share Schemes Team newsletter') and which, I would suggest, is only of interest to share scheme specialists.

Thirdly, 'Spreadsheets and substitute forms can be used, but they must give the details specified on form 42'. At first sight I thought this might be useful — all incorporations could be put onto one spreadsheet and each agent could send a single letter to Room 76 to cover all incorporations for the year. But what about the signature? Therefore it seems to me that we still need to submit a spreadsheet for each client and get it signed.

Finally, 'there is no need to submit form 42 where form CT41G has been submitted and it contains the information required on form 42'. This might be useful to know for future years, but form CT41G does not require the company to disclose some of these details and so very few practitioners will have provided them voluntarily. Also, there is no requirement on form CT41G (as there is on form 42) that it be signed by the company secretary. Surely this invalidates the submission of details on form CT41G?

Has the Inland Revenue lost all respect for the professions?

Finally, I was very disturbed by one particular comment when, having established that the idea of a concession had been considered, but rejected, I asked why it had been rejected. The answer was that the Revenue considered that not everybody would abide by it. I pointed out that practitioners will only take advantage of a concession where they are confident that they satisfy all the necessary criteria. 'I'm not so sure about that', was the reply. This makes me wonder whether the Revenue has lost all respect for the professions. If that is the case, then it is a very sad day for all of us — not just those who are frantically filling in forms 42. I am aware that there are 'tax avoidance schemes' which are based on non-disclosure, but any respectable adviser will not even look at them (never mind recommend them for a client). It is time that the Revenue realises this and tries to make life a little easier for the very compliant majority. If the Government can also be persuaded to listen to us at the consultation stage to enable legislation to be better targeted, then hopefully things can improve in the future. They cannot get much worse than they are at the moment.

Martin Riley is a director of Isis Tax Consultancy Ltd and can be contacted by phone on 0115 981 8550 or via his e-mail address: martin@isistax.co.uk. The views expressed in this article are those of the author.

Issue: 3965 / Categories: