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THE FINANCE BILL contained a new clause 62 and Schedule 14 updating the enterprise management incentives scheme legislation at Schedule 14 of the Finance Act 2000. The Social Security Contributions (Share Options) Regulations 2001 and the Social Security Contributions (Share Options) Act 2001 are two pieces of sister legislation that provide transitional relief in connection with National Insurance contributions on employee share options; the latter was considered in the article in last week's issue of Taxation by Mark Saunders.
The legislation relating to employee shares is particularly bewildering, as it seems that hardly does a month or two pass, without more being produced. Often, all that the new legislation does is correct earlier anomalies. Indeed, many of the changes now being introduced might well have been considered when the original legislation was drafted.
Notification deadline extended
The somewhat tight deadline of 30 days for notification to the Inland Revenue of granting of an option is extended to 92 days. This is far more sensible, and would have been even more welcome had it been introduced at the inception of the legislation, rather than a year later.
Removal of employee limit
The major change to enterprise management incentives schemes in the Chancellor's November 2000 pre-Budget report was the removal of the maximum number of employees from any company who can benefit from the scheme. As readers will know, the original suggestion was that this limit should be six employees. This figure was successively increased to ten and 15, but with the Finance Act 2001 disappears completely.
In order to maintain some kind of limit over the options that can be granted, there will be a new maximum value of options for any companies (or groups) of £3 million. This will be calculated by reference to the value of options at the date on which the options were granted. For this purpose, the valuation ignores any reduction for minority holdings. If the grant of an option means that the limit is breached, then the excess over £3 million will not be regarded as a qualifying option. Unfortunately, if more than one option is granted at the same time and the limited is breached, then it would be necessary to divide the excess pro rata to decide which options qualify and which do not. An employer looking to grant options that may lead to the limit being exceeded should take care. The Revenue's Shares Valuation Division in Nottingham is willing to agree valuations in advance of grant, and there will be great benefits in doing so in such circumstances. The thought that any employer might have 20 or 30 employees all of whom have options that are granted partly in accordance with the legislation and partly outside it seems madness. The original assumption when the legislation was introduced that the individual limit would disappear completely has proved unduly optimistic. This has rested at £100,000 since the proposals were originally devised, and is set to continue. This means that the notion that a company could be sold for up to £3 million to a single employee under this legislation will not be a possibility. In view of the fact that this legislation only applies to companies with gross assets not exceeding £15 million when the options are granted, it seems unlikely that many companies will be able to take advantage of the possibility of granting options worth as much as £3 million. However, the individual limit of £100,000 is one that many fast growing entrepreneurial companies would like to have seen lifted to a more realistic figure. A figure proposed at the time of the November announcement was £250,000.
Relief for option cost
There is a great deal of legislative amendment to give employees tax relief on the sums they have paid to purchase their options. This is in addition to the relief that is already given for the acquisition price on the exercise of those options. The amendment is complicated and, in practice, its value is negligible. Options are mostly granted under deed, so no relief will result from about a hundred lines of legislation. Even where options are granted for consideration, this is almost always £1 for the total number of options offered to an employee.
Removal of key employee clause
One of the consequences of lifting the 15-employee limit relates to the statement the companies must make. In the past, they had to state that an option was being granted in order to recruit or retain a key employee. In future, the word 'key' will be removed from the legislation, although it is still necessary to grant the option in order to recruit or retain an employee and not with a view to avoiding tax. This represents a complete change in the ethos of the enterprise management incentives scheme. When it was originally created, it was specifically designed to help smaller fast-growing entrepreneurial companies offer shares and benefits to their key employees. This was a subtle way of saying that dot.coms could have an incentive to pay employees in shares when no cash was available. Now, it can be used as an all-employee share scheme for smaller companies. This begs the question why the Government has decided to make this sea change. It is possible that since the arrangements were originally set up, the perceived need to benefit fast-growing dot.coms is not as pressing as it was in 1998 and 1999. Therefore, it has been dusted down and is being recycled as an all-employee scheme for small companies. Whatever the reason, the benefits to be derived from the relaxation are substantial and any qualifying trading company that does not breach the £15 million asset limit should seriously consider the use of the scheme as part of its package of employee benefits.
Disqualifying events
The other changes in the Finance Act 2001 concern disqualifying events. Previously, where there was an alteration in the share capital, it would be regarded as a disqualifying event unless the Revenue had given prior approval. This provision is removed. In its place, a disqualifying event is deemed to take place where there is an alteration in share capital and the effect is either that the requirements of the legislation would no longer be met in relation to the option, or the market value of the shares has been increased. This latter would apply either where the alteration is not made for commercial reasons, or the main purpose or one of the main purposes of making the alteration was to increase the market value of the shares subject to the option.
Advance assurance
A further announcement was made at the time of the Budget, which introduced the concept of advance assurance with regard to whether a company qualified under the legislation. Such advance assurance can be sought at any time after 5 April 2001. This means that, for example, where a company is partly involved in property development and partly in property management, it can seek a ruling from the Revenue as to whether it will qualify for the enterprise management incentives scheme. While this is welcome, a further advance assurance with regard to other matters such as the qualification of employees would have been equally useful.
There is also a problem with such advance assurances that circumstances may change which would invalidate them. Using the example above, a company might only need to buy one more property for development to breach the (already arbitrary) limit at which point the assurance would be invalidated.
Get it right first time!
While the various amendments are welcome, there is no substitute for getting legislation right first time around. The removal of the 15-person limit and the introduction of the £3 million limit are, however, a useful start. To keep the impetus going, it would be good to see further relaxations from the Government. These might include an individual limit of £250,000 and the extension of the scheme to all companies.
Philip Fisher is the employee benefits partner at Chantrey Vellacott DFK. The company has recently launched a new website. A full archive of Philip's articles on employee share schemes is available on the site. Philip Fisher can be contacted on 020 7509 9453 or by email.
