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Lord Higgins: My Lords, the House will have felt a sense of deja vu when the noble Lord moved his amendment because in the previous welfare Bill we encountered considerable problems regarding the IT industry, the danger of people going abroad and so forth.

Like the noble Lord, I have also had correspondence from and NTL.

Baroness Hollis of Heigham: My Lords, they cancel each other out.

Lord Higgins: As the noble Baroness says; we will have to consider which end of the argument we favour. Perhaps the quickest way for the Minister to reply would be to say she agrees or disagrees with or NTL. Having said that, there is considerable overlap and concern.

There may be implications, as last year, for the international mobility of companies. The evidence seems a little conflicting because there may be problems with the American accountancy system as well as of taxation in this country. It is unfortunate that this issue has arisen late in the day, although that is in no sense the Government's fault. We will see what arrives in our e-mail--no doubt in droves--between now and Third Reading.

There is concern that the Government's proposals do nothing to address historical liabilities on existing share options, which need to be taken into account. One of the companies says that it is illogical and unfair that employers will have to pay national insurance on the price of the shares they grant when they will only benefit from an increase in the value of the shares; and that employees will face an unfunded tax liability, which would be particularly regressive for employees new to share ownership. Similarly, employers who have yet to move into profit will face unfunded tax burdens. Clearly, when share prices go up and down this is a very difficult situation overall. The noble Lord, Lord Goodhart, was inclined to refer to share prices going up but they can also go down. At the

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moment prices are going up and down like a yo-yo. The exact moment when the tax charge hits may be of considerable significance. The charge may arise at a time when the price goes up but the individual may have to pay it at a time when the price has reduced. This is a simple matter, and I hope that the noble Baroness is able to explain it in words of one syllable.

Baroness Hollis of Heigham: My Lords, I want to be very careful in what I say. Obviously, one is considering certain liabilities, quite apart from jokes about company representations cancelling out each other. Having given a reasonably full reply--this is a matter of concern which noble Lords were unable to debate at Committee stage--I am happy to repeat the offer, if it is of assistance, of a further meeting before Third Reading between officials and the noble Lords, Lord Goodhart and Lord Higgins, to pursue the matter in a way that we cannot on the Floor of the House. Because the amendments were tabled rather late noble Lords were unable to debate the matter fully in Committee.

I start by explaining briefly the purpose of the Government's position. I shall then explain why I recommend that the House reject the amendment moved this evening. Some background may be helpful. Noble Lords will be aware that my honourable friend the Financial Secretary has been consulting employers with a view to finding a technical solution to a problem that has arisen in relation to national insurance contributions on share option gains. Since 6th April 1999 gains made by employees when they exercise unapproved share options granted after 5th April 1999 are subject to Class 1 NICs. This means that the NICs charge is now on the same basis as income tax through PAYE.

This has caused a number of problems for employers. Companies have informed us that, while they can plan for NICs on regular pay, it is more difficult for them to plan on share option gains, particularly where the share price behaves like a yo-yo, as the noble Lord, Lord Higgins, suggested, as in the high-tech sector of the economy. Employers are required to make a provision in their profit and loss accounts for the accruing NIC liability, based on the market value of the shares at the relevant accounting date. The need to make this provision can make some companies technically insolvent. Exposure to an unpredictable NICs liability can also mean that some companies miss their performance targets. When that happens the market response can be devastating.

Class 1 national insurance contributions consist of a primary contribution which is payable by the employee and a secondary contribution which is payable by the secondary contributor, who in most circumstances is the employer. Current social security legislation provides a statutory bar to prevent employers from recovering any part of their secondary Class 1 liability from the employee. The government amendment introduced in Committee strengthens that

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protection for the employee, but at the same time introduces an exception for NICs arising on share option gains.

The government amendment does three things. First, it allows employers and employees to reach an agreement that a secondary contributor (usually the employer) may recover from the employee some or all of the secondary NICs in respect of rights to acquire shares. I emphasise that it is the employer and that it is voluntary. Secondly, as an alternative, the employer may make an application for approval of an election to the Board of Inland Revenue. If approval is obtained, the employer and employee can jointly elect to transfer all or some of the liability to pay the secondary NICs on the share option gain to the employee. Elections can be made only after the Inland Revenue has given its approval to the form of the election and the accompanying arrangements for securing that the NICs liability transferred to the employee is paid.

The ability to transfer the liability has been proposed as a direct response to representations made to the Financial Secretary during the consultation exercise. We have worked with several high growth companies to introduce a solution which will overcome accounting difficulties for companies that report in the United States that would otherwise arise if the employer simply recovered the NICs.

Thirdly, our amendment strengthens the existing statutory bar that prevents the employer recovering any part of the secondary NIC in respect of all forms of earnings (subject to the new exception for share options). It extends protection to the employee by ensuring that the person liable to pay the Class 1A NICs (on benefits in kind) or Class 1B (on PAYE settlement agreements) cannot recover his liability from the employee. I emphasise that the amendment that the Government introduced at Committee puts in place a solution that a number of companies have requested, and we are meeting those requests. The Government have consulted widely on this solution, and it is clear that many companies to whom we have spoken are eager to set up such arrangements.

The merit of this solution to companies is that it can eliminate or neutralise the need to make a provision for the accruing NIC liability in their accounts. It can remove the difficulties on the employer's cash flow caused by the need to pay NIC based on an unpredictable share price and the uncertainty caused by not knowing when the employee will exercise the option. The Government's proposal will allow the NIC liability to be moved to the employee who has control over when the option is exercised and who will have funds or shares which can be sold to meet the liability.

Noble Lords asked in Committee whether an employee who agreed to take on the responsibility for the secondary NIC would still be required to do so if the option had gone "underwater". I can confirm that the employee would not be required to pay NIC on the exercise of such an option as the employee would not make a gain in the circumstances where he has to pay

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more for the shares than he could buy them for on the open market. Indeed most employees would not exercise the option in such circumstances.

The amendment we introduced in Committee will help to attract business and jobs to the UK and help UK companies compete in the global market. It goes towards meeting the Government's aim of a fairer NI system by ensuring that NICs are paid on share options and not treated more favourably than other forms of remuneration. It is also cost neutral on the National Insurance Fund.

10.30 p.m.

Lord Higgins: My Lords, perhaps the noble Baroness could slow down just a little.

Baroness Hollis of Heigham: My Lords, I thank the noble Lord. I deal now with the amendment tabled by the noble Lord, Lord Goodhart, and the noble Earl, Lord Russell. As I mentioned to the House earlier, social security legislation currently provides a statutory bar to prevent employers from recovering any part of their Class 1 liability from the employee. The first effect of this amendment would be to ensure that Class 1A (NICs liability on benefits in kind) and Class 1B (NICs liability on PAYE voluntary settlement agreements) would remain excluded from this statutory bar. I am sure that I can count on support from all sides of the House in suggesting that we do not want to leave the employee exposed in this manner.

The second effect of this amendment would be to move the NICs charge from the exercise of unapproved options to the "intrinsic" value of the options at the date of grant. This would mean that employees and employers would have to pay NICs regardless of whether the options are eventually exercised or if the value of the shares were to fall. So NICs would have to be paid purely on the expectation of a realisation of value and not a tangible gain in value; the NICs payable would not reflect the gain that the employee actually made.

Many high growth companies have told us that they grant share options because they are unable to offer competitive cash salaries, particularly when they start up in business. This amendment would mean that these companies would face an NICs charge when they grant options to employees--at the time when they are least likely to be able to pay. We see a number of difficulties with the noble Lord's proposals. First, employees would be required to pay NICs at the time they receive the option. This could mean that they have to pay at a time when they have insufficient cash to meet their liabilities. Currently, employees can sell some of their shares when they exercise their options to meet their liabilities.

Secondly, we would go back to the position that existed for NICs pre 6th April 1999, and so take the NICs charge back out of alignment with the income tax charge through PAYE. This will mean that PAYE and NICs will have to operate on two different figures. Employers said at the time that this caused considerable administrative problems.

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Thirdly, the amendment will increase administrative costs for employers and the Inland Revenue, due to the added complexity of accurately valuing options over shares at the time of grant--and there is considerable difficulty in identifying a method that would allow this to be done accurately. Employers would be required to operate a valuation model such as that provided in the Black Scholes Model. These models do not always easily apply themselves to high growth and unquoted companies. It will mean that options will have to be valued at grant for NICs purposes and again at exercise for income tax purposes--in other words, what happens when one disjoins them. Currently a valuation for income tax through PAYE is also acceptable for NICs.

Fourthly, the position that existed prior to 6th April 1999 will re-open an avoidance route that was used by companies, particularly in the City, to pay large bonuses to directors, and other highly paid employees, free of NICs. Any proposal to scale back the current NICs charge and charge it at grant brings with it the opportunity for new forms of avoidance.

Fifthly, the effect of this amendment would be that employees and employers who are paid in cash would pay more NICs than employees and employers where share options form an integral part of the remuneration package. The Government believe that that is unfair. I thought the noble Lord, Lord Goodhart, too, felt this was unfair, given his remarks at Committee stage.

Sixthly, the effect of this amendment would reduce income to the National Insurance Fund. The amount is difficult to predict because it is based on the volatility of the share price, but our provisional estimate is that it is likely to cost the National Insurance Fund in the region of £350 million a year. This could also result in a move away from bonuses paid in cash to share options and some substitution of cash pay with share options. If this were to happen the loss to the National Insurance Fund could be multi-millions. This could also affect employees' entitlement to contributions-based, earnings-related and work-related payments such as statutory sick pay or statutory maternity pay.

Finally, perhaps I may mention, after those six compelling arguments, a small technicality, which is that the amendment as drafted will not apply to Northern Ireland legislation, where NICs would remain payable on the exercise of unapproved options.

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