Clause 531: Limitation of charge on exercise of option to acquire shares below market value

2148.     This clause sets out how to calculate the amount chargeable under clause 476 when a qualifying option (or replacement option) is exercised to acquire shares for less than their market value when the option was originally granted. It derives from paragraph 45 of Schedule 14 to FA 2000.

2149.     This provision is subject to clause 532 which outlines what happens if a disqualifying event takes place.

2150.     In this and in the succeeding clause, which provide the basis for the calculation of the charges, there are formulae to aid understanding of the text.

2151.     There is no successor to paragraph 46 of Schedule 14 to FA 2000 (exercise of option to acquire shares at nil cost). This is redundant in that it is a variation of the situation in this clause. Small changes have been made to clauses 531 and 532 to ensure that the whole picture is preserved. In subsection (1) of clause 531 there is a new "(or at nil cost)" and in both subsection (2) of this clause and subsection (4) of clause 532, a reference to "if any" in the definition of "ACS".

2152.     There is a further point affecting both this and the next clause. In the source legislation, there was a provision that stated that if the clause 476 gain was nil there is no liability to income tax. Clauses 531 and 532 now use a formulaic approach and a more general solution has been found to deal with negative results. Clause 420 provides for the position where a formula in Part 7 would produce a negative result. The result is to be taken to be nil.

Clause 532: Modified tax consequences following disqualifying events

2153.     This clause sets out what happens where there has been a disqualifying event and the option had not been exercised within 40 days of that event. The 40-day period of grace is in recognition of the fact that the option-holder may have no control over a disqualifying event.

2154.     This provision derives from paragraph 53 of Schedule 14 to FA 2000. The clause now has a more comprehensive heading and is in a more prominent position before the clauses describing the various types of disqualifying event. This draws out the impact of such an event on income tax relief.

2155.     The broad effect of the amendment in FA 2001 was that this set of rules wholly replaces those included in clauses 530, and 531, if a disqualifying event occurs. There is a slight change in the wording to reflect this, referring to the option being "within", for example, clause 530, rather than clause 530 applying.

2156.     The effect of the provision is to separate out and relieve the gain in the value of the share option accruing over the period up to the disqualifying event, leaving any gain accruing between the disqualifying event and the date of exercise fully chargeable. There is of course the usual deduction for anything paid for the grant of the option.

2157.     As noted in relation to the preceding clause there is no successor to paragraph 46 of Schedule 14 to FA 2000. Another small change has been made to this clause to ensure that the whole picture is preserved. In subsection (4) there is an added reference to "if any" in the definition of "ACS".

2158.     The provision in sub-paragraph (2D) of paragraph 53 of Schedule 14 to FA 2000, has not been reproduced. This was a provision that stated that if the clause 476 gain was nil there is no liability to income tax. This and the preceding clause now use a formulaic approach and a more general solution has been found to deal with negative results. Clause 420 provides for the position where a formula in Part 7 would produce a negative result. The result is to be taken to be nil.

2159.     There is a clearer exposition of the rule in subsection (6), which derives from paragraph 53(3) of Schedule 14 to FA 2000. This ensures that the operation of this clause does not result in a higher taxable amount than would be charged under clause 476, if the EMI provisions did not apply. In this situation no part of either this clause or of clauses 530 and 531 apply (and so the amount is counted as income under clause 476).

Clause 533: Disqualifying events

2160.     This is a new provision, which provides the reader with a list of the possible disqualifying events and notes where they are described in full.

Clause 534: Disqualifying events relating to relevant company

2161.     This clause sets out those events that can happen to the company whose shares are the subject of a qualifying option that would lead to that share option ceasing to qualify under EMI. These are "disqualifying events". It derives from paragraph 47(1) and (2) and paragraph 48 of Schedule 14 to FA 2000.

2162.     The word "being" has been changed to "becoming" in subsection (1)(b) to better match the wording and meaning of subsection (1)(a).

2163.     The definition of "control" is covered by section 840 of ICTA, see Note 51 in Annex 2.

2164.     In subsection (4), which derives from paragraph 47(2) of Schedule 14 to FA 2000, the reference to the "original" option has been dropped from the phrase "when the option was granted". There is no scope in paragraph 47(2)(b)(ii) of Schedule 14 to FA 2000 to refer to any option other than the qualifying option, mentioned in paragraph 47(2)(a) (in subsections (3) and (4)(a) of this clause). This could be either an original or a replacement option. Also the words "of a group" no longer follow "parent company" in subsection (4)(b).

2165.     To clarify the position if there has been a replacement option, there is a cross-reference to paragraph 41(5) (b) of Schedule 5.

2166.     The words "from the grant" in the source legislation have been changed to "the period of two years after the date" of the grant in subsection (5) to clarify the rule. This new wording provides for a period exclusive of the date of the grant.

Clause 535: Disqualifying events relating to employee

2167.     This clause sets out the disqualifying events that can occur in relation to an employee. These result in the share option held by that employee ceasing to qualify under EMI. It derives from paragraphs 47(1) (part), (3), and 52(1), (2) and (6) of Schedule 14 to FA 2000 and relates to provisions in Schedule 5 to this Bill. It picks up on some new expressions introduced in paragraph 26 of that Schedule to set out more clearly the requirement on working time.

2168.     First there is the employment requirement in subsection (1)(a). Next, under subsection (1)(b), there is a disqualifying event if, on the facts of the arrangement between employer and employee (usually the contract), the employee ceases to meet the requirement as to commitment of working time, contained in paragraph 26 of Schedule 5 to this Bill.

2169.     Finally, and the different nature of this test is emphasised by the words "in addition" in subsections (2) to (5), there is what is known as the "working time rule". This takes into account the time actually spent by the employee on work in the relevant employment.

2170.     The provisions in paragraphs 47 and 52 of Schedule 14 to FA 2000 were cumbersome to operate, did not work satisfactorily in all circumstances and could impact harshly on employees working flexi-time. Under subsections (2) to (5) there is a much simpler "working time rule". See Change 130(A) in Annex 1.

2171.     There is another minor change to the law in subsection (3). This corrects an omission in the source legislation, by providing a cross-reference to paragraph 26(3) of Schedule 5 to this Bill. See Change 130(B) in Annex 1.

Clause 536: Other disqualifying events

2172.     This clause lists the other events that can result in a share option ceasing to qualify under EMI. It derives from paragraphs 47(1) and 51 of Schedule 14 to FA 2000.

Clause 537: Alterations of share capital for purposes of section 536

2173.     Among the disqualifying events in clause 536 are certain kinds of alteration of the company's share capital. Clause 537 sets out what kind of alteration comes into play for the purposes of clause 536(1)(b) and (c). It derives from paragraphs 47(1) and 49 of Schedule 14 to FA 2000.

2174.     There is a change in the wording in subsection (4) compared to the final paragraph of paragraph 49(1). "References to restrictions .. or to rights .. include", followed by an interpretation, is replaced by "any reference to a restriction .. or a right .. is a reference to such a restriction .. or right", followed by the same interpretation. This rephrasing makes better sense of the final words in the sentence, "or in any other way".

Clause 538: Share conversions excluded for purposes of section 536

2175.     Among the disqualifying events in clause 536 is a conversion of the shares, to which the option relates, into a different class. Clause 538 prevents a share conversion being a disqualifying event if it meets certain conditions as set out in subsections (2) and (3). This clause derives from paragraph 50 of Schedule 14 to FA 2000.

Clause 539: CSOP and other options relevant for purposes of section 536

2176.     Among the disqualifying events in clause 536 is the grant of a CSOP option if, after this grant, the total value of the shares for which the employee holds unexercised employee options under EMI or CSOP exceeds £100,000. This clause explains the meaning of CSOP options and employee options for those purposes. It derives from paragraph 51(1) to (4) of Schedule 14 to FA 2000.

2177.     There is a new definition of a group of companies, in contexts where there is no reference to the parent company, in paragraph 58 of Schedule 5 to this Bill.

Clause 540: No charge on acquisition of shares as taxable benefit

2178.     This clause prevents there being a charge to tax under Chapter 8 of Part 3 in respect of shares acquired by the exercise of a qualifying option, if the employee is resident and ordinarily resident in the United Kingdom. This derives from paragraph 54 (1) of Schedule 14 to FA 2000.

2179.     The wording of the source legislation suggests that the residence tests apply at the time the option is exercised. In practice the Inland Revenue has applied the test at the time of the grant of the option. In this clause it has been made clear that the tests can be applied at the time of the grant or at the time of the exercise of a qualifying option. See Change 131 in Annex 1.

2180.     The content of paragraph 54(2) of Schedule 14 to FA 2000 is now in the next clause, clause 541, since it relates to a charge under Chapter 9 of Part 3 which is not affected by the EMI provisions.

Clause 541: Effects on other income tax charges

2181.     The fact that a share option may be a qualifying share option under EMI does not prevent the ordinary operation of certain other income tax provisions. This clause sets out what those provisions are. This includes a reference to the possibility of a charge under clause 453 in subsection (1)(c). This last subsection derives from section 79 of FA 1988 and, though not immediately relevant since an EMI option cannot be granted over shares in a subsidiary, can apply to shares acquired on exercise of the option if there is a subsequent take-over.

2182.     The clause also describes what relief may be available as a deductible amount from a charge to tax under clauses 427 or 438 in respect of shares acquired under the option.

2183.     This clause derives from paragraphs 54 (2) and 55 of Schedule 14 to FA 2000.

Chapter 10: Priority share allocations

Overview

2184.     This Chapter derives from section 68 of FA 1988 which came into force on 23 September 1987. That section exempts the benefit derived by directors and employees from a priority allocation of shares.

2185.     Section 68 of FA 1988 starts by granting a complete exemption from the charge as earnings in respect of any benefit derived from an entitlement to a priority allocation of shares. Then, in some circumstances, the legislation brings back into charge the discount enjoyed by employees. It does so by excluding the relevant amount from the initial exemption. The rules for calculating this amount are different from the normal rules for calculating emoluments.

2186.     When section 68 of FA 1988 was enacted, it only dealt with relatively straightforward offers where there was a single public offer under which both members of the public and directors and other employees applied for shares including any priority shares.

2187.     Successive amendments catered for more complex share offers. These included offers where, because of legal and other technical issues, the priority shares for directors and employees were subject to a separate employee offer. Each new tranche of legislation was "bolted on" to what had gone before. This was done by imposing the fiction that the separate public and employee offers were in fact a single offer - "the offer".

2188.     This led to some rather dense and convoluted legislation - particularly in the rules for the limits on the number of priority shares and the "similar terms" condition. In order to try to make the provisions easier to understand, that fiction has been abandoned and the Bill instead uses the following structure: clauses 542 and 543 deal with single share offers; clauses 544 and 545 deal with share offers with separate public and employee offers; and clauses 546 to 548 deal with supplementary material that is common to both.

2189.     It should be noted that section 68(4) FA 1988 (dealing with the capital gains aspects) does not appear in this Chapter. Paragraph 212 of Schedule 6 inserts a new section 149C in TCGA 1992. In addition section 68(6) of FA 1988, the original commencement provision, is omitted on the grounds that it is spent.

Clause 542: Exemption: offer made to public and employees

2190.     This clause is concerned with offers which are open to both the public and employees. Subsection (1) derives from section 68(1) of FA 1988 and introduces the basic conditions for the exemption. The exemption itself is found in subsection (2) and is from liability to income tax as earnings. It follows that the exemption does not apply to a benefit received in connection with a change or termination within section 148 of ICTA (see section 148(2)(b)).

2191.     Subsections (3) to (6) derive from sections 68(2), (2A) and (2B) of FA 1988 and give the detailed conditions which must be satisfied in order for the exemption to apply. In contrast to the source legislation, dealing with the conditions one by one should be clearer.

2192.     Subsection (7) introduces clause 543 which excludes certain discounts from the exemption in this clause.

Clause 543: Discount not covered by exemption in section 542

2193.     This clause derives from section 68(1A) of FA 1988 and excludes from the exemption in clause 542 the benefit of certain discounts enjoyed by a director or employee in acquiring the priority shares. The discount therefore remains taxable as earnings. In calculating the taxable amount the measure of any registrant discount (see clause 547) is disregarded.

Clause 544: Exemption: different offers made to public and employees

2194.     This clause is concerned with cases where there are separate offers to the public and employees. Subsection (1) derives from section 68(1ZA) of FA 1988 and introduces the basic conditions for the exemption. The exemption itself is found in subsection (2) and is from liability to income tax as earnings. It follows that the exemption does not apply to a benefit received in connection with a change or termination within section 148 of ICTA (see section 148(2)(b)).

2195.     Subsections (3) to (6) derive from sections 68(1ZB), (2), (2A), (2B) and (2C) of FA 1988 and give the detailed conditions which must be satisfied for the exemption to apply. Subsection (3) requires the case of each company whose shares are subject to the employee offer to be considered. In the FA 1988 provisions, the fiction that the public offer and the employee offer are a single offer means that, reading subsections 68(2)(a) and 68(2C) together, a company whose shares are only subject to the public offer also has to be considered. In such a case, the limit on the number of shares allocated to employees, imposed by section 68(2)(a), will never be exceeded. These companies are not therefore mentioned. See Note 52 in Annex 2.

2196.     Subsection (7) introduces clause 545 which excludes certain discounts from the exemption in this clause.

Clause 545: Discount not covered by exemption in section 544

2197.     This clause derives from section 68(1) of FA 1988 and excludes from the exemption in clause 544 the benefit of any discount (disregarding the registrant discount) enjoyed by a director or employee in acquiring the priority shares. The discount therefore remains taxable as earnings.

2198.     Subsections (3) to (6) derive from the rather complex provisions in section 68(5B) and (5C) which determine the aggregate "notional price" of the shares in the offer. There are special rules where that price is different from the actual fixed price or the lowest tendered price. In those circumstances it is necessary to calculate the "appropriate notional price" for the shares in question. A formula has been introduced to try to make the basis of the calculation clearer.

Clause 546: Meaning of being entitled "on similar terms"

2199.     This clause derives from sections 68(3) and (3A) of FA 1988 and explains the condition that entitlement to a priority allocation of shares must be on "similar terms".

2200.     Subsections (3) to (6) only apply where the allocation of shares in a company for directors and employees of the company is different from the allocations for directors and employees of other companies.

Clause 547: Meaning and amount or value of "registrant discount"

2201.     This clause derives from section 68(5A) of FA 1988 which defines "registrant discount". Section 68(5A)(b) requires at least 40% of shares which are allocated to members of the public other than employees and directors to be allocated to individuals entitled to the discount. It is not made explicit what this phrase means Subsection (4) has been drafted to make clear that the intention is to exclude employees and directors who are entitled to a priority allocation. This change in approach is explained in detail in Note 53 in Annex 2.

2202.     In this clause the label "subscribing employee" has been used to describe those directors and employees who subscribe for shares under the offers and who comply with the same registration requirements as members of the public.

Clause 548: Minor definitions

2203.     This clause contains the definitions used in this Chapter and mainly derives from section 68(5) of FA 1988. That legislation does not define "director" (except to include prospective and former directors) or "shares" and the definitions here have been taken from section 168(8) of ICTA and section 288 of TCGA 1992 respectively. See Change 132 in Annex 1.

Chapter 11: Supplementary Provisions about employee benefit trusts

Background

2204.     Chapters 6, 7, 8 and 9 of this Part set out the provisions for the four types of share scheme: share incentive plans ("SIPs"), Save As You Earn option schemes ("SAYE"), company share ownership plans ("CSOPs") and enterprise management incentives ("EMIs").

2205.     Each of those schemes includes a number of requirements that the employee must meet. One of the conditions common to each of the schemes is that the employee must not have a "material interest" in the company whose shares are subject to the scheme. A "material interest" means entitlement to more than a certain percentage of the relevant company's share capital.

2206.     In determining whether or not the "material interest" test is satisfied, the entitlement of the individual to any of the company's shares includes any such entitlement held by any "associates" of the individual.

2207.     One kind of associate could be a trustee of a settlement of which the individual is a beneficiary. And one kind of trust that may well exist in the context of a company that is running share incentive schemes is an employee benefit trust. An employee wishing to participate in the share scheme may therefore need to know whether or not to count the trustees of the employee benefit trust as "associates" for the purposes of the "material interest" test.

2208.     Each of the four types of share scheme mentioned in paragraph 2204 includes provisions directed to the issue whether the trustees of an employee benefit trust should be counted as associates. The provisions are to the same effect, and state, in each case, that the general rule is that the trustees are not counted as associates if neither the individual in question (with or without associates) nor any associate of the individual (with or without associates) controls more than a stated percentage of the ordinary share capital of the company.

Overview

2209.     This Chapter contains provisions relating to employee benefit trusts. It deals with two issues.

2210.     The first issue dealt with is the obvious question "What is an employee benefit trust?". In the source legislation an employee benefit trust is stated, in the case of each of the four schemes, to have the same meaning as in paragraph 7 of Schedule 8 to ICTA. That Schedule is not being re-enacted, as it relates to profit-related pay schemes which will be effectively spent by the time that this Bill takes effect. It will therefore no longer be possible to refer to the meaning of "employee benefit trust" as used in the legislation relating to profit related pay schemes. That definition, instead, is set out in this Chapter. The definition, in clauses 550 and 551, derives from paragraph 7 of Schedule 8 to ICTA.

2211.     The second issue dealt with relates to the general rule mentioned in paragraph 2208: for there are cases where the general rule is supplemented by further rules. In these cases, which depend upon the employee or an associate receiving a payment from the employee benefit trust, the employee (or the associate) is treated as owning the "appropriate percentage" of the ordinary share capital of the company, in addition to any percentage of that share capital actually owned. These provisions, in clauses 552 to 554, rewrite paragraph 7(9) to (12) of Schedule 8 to ICTA.

Clause 549: Application of this Chapter

2212.     This clause sets out the ambit of this Chapter. Subsections (1) to (3) are drafting additions, while subsection (4) derives from material in paragraph 7(3) and (12) of Schedule 8 to ICTA.

2213.     In subsection (4)(b), the words "the company which are subject to" have been added near the end of this provision. Although these words do not form part of paragraph 7(12), it is thought that they should have been included, and that the legislation is easier to understand if they are included. See Note 54 in Annex 2.

2214.     Subsection (5) provides that, in this Chapter, the term "employee" includes the holder of an office. This general proposition holds good for the employment income Parts (see clause 5), but was disapplied for the purposes of Part 7 in clause 421. However, the provisions of this Chapter are governed by the definition of the term "employment" in section 169(1) of ICTA, which includes an office, so the general proposition that an "employee" includes an office-holder has been reinstated.

Clause 550: Meaning of "employee benefit trust"

2215.     This clause sets out the basic ingredients of an employee benefit trust, as follows:

• all or most of the employees of the company must be eligible to benefit; and

• apart from certain exceptions, there have been no disposals of property subject to the trust since 13 March 1989.

2216.     This clause derives from paragraph 7(5) of Schedule 8 to ICTA.

2217.     Subsection (4) provides more information about the exceptions to the "no disposals since 13 March 1989" rule. Disposals that are allowed are those made in the ordinary course of the management of the trust and "qualifying disposals", as defined in clause 551.

Clause 551: "Qualifying disposals" for purposes of section 550

2218.     This clause sets out that a "qualifying disposal" can be of any of the ordinary share capital of the company, or money paid outright, provided one of three conditions is met. This clause derives from paragraph 7(6) and (7) of Schedule 8 to ICTA.

2219.     The conditions mentioned are set out in subsections (2), (4) and (5).

2220.     Subsection (3) is new. Although subsection (2) refers to "employees of the company", it is Inland Revenue practice to extend the benefit of this provision to employees of a subsidiary company (a subsidiary company being taken to mean a company under another company's control, with the word "control" taking the meaning in section 840 of ICTA). Subsection (3) reflects that Inland Revenue practice. See Change 133 in Annex 1.