"Non Dom" Reforms - Impact On Employee Share Plans.

The provisions of the Finance Bill 2008 will, if enacted, make significant changes to the way in which employees who are resident but not ordinarily resident in the UK will be taxed in the UK. The changes include the introduction of an alternative basis of charge for tax purposes - the "remittance  basis": This briefing reports on the impact of the changes in the context of employee share plans.

Employee Share Options Employees who are not both resident and ordinarily resident in the UK on the date of grant of employee share options are not currently taxed on the same basis as employees who are both resident and ordinarily resident in the UK at that time in respect of those employee share options. Resident and ordinarily resident employees are currently taxed under Chapter 5 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). As a result of the changes made by the Finance Bill, employees who are UK resident but not ordinarily UK resident will also be taxed under Chapter 5 in respect of options granted on or after 6 April 2008. As a result, such employees will be subject to a charge to income tax on exercise of a non-HMRC approved employee share option on the "option gain". Previously, the employee would have been treated as receiving a notional beneficial loan equal to the option gain and would therefore have incurred an annual income tax charge until disposal of the shares acquired on exercise of the option and, potentially, a further income tax charge on sale of the shares. It is not necessarily the case that all of the income arising on exercise of the option will be subject to income tax. Where the employee has elected to be taxed on the "remittance basis", the income tax charge will depend on (a) the extent (if at all) to which the duties of the employment are performed in the UK; and (b) the extent to which the income arising in connection with the employee's non-UK duties (which is deemed to be "foreign income") is remitted to the UK. In circumstances where an employee who is not ordinarily resident in the UK has chosen to be taxed on the remittance basis and performs the duties of his employment wholly outside the UK, the only taxable income arising from the exercise of options relating to that employment will be any part of that income remitted to the UK. However, if the employee carries out his employment duties both in and outside the UK, the income is likely to be apportioned between his UK and non-UK duties on a "just and reasonable basis". Where this applies, income apportioned to duties in the UK will be subject to income tax whereas the income apportioned to non-UK duties should only be subject to UK income tax if remitted to the UK. Whilst the apportionment rules limiting the UK income tax charge in respect of "foreign income" appear helpful, it is our understanding that HM Revenue and Customs (HMRC) will treat any foreign income arising in connection with the exercise of options in respect of shares in a UK incorporated company as remitted in full to the UK, on the basis that the shares are already within the UK when issued. Amendments to the Finance Bill have clarified the extent to which the employee's employer will be required to operate PAYE on the amount that, on the basis of the best estimate that can reasonably be made, is likely to count as employment income of the employee after deduction of the amount that, on the basis of such an estimate, is likely to be "foreign income". It is currently unclear whether the apportionment rules which apply to income tax will also apply to any national insurance liability that arises in respect of the exercise of employee share options by employees who are resident but not ordinarily resident in the UK.

All-Employee Share Plans One of the key features of the two types of UK "all-employee share plan", being the Savings Related Share Option Scheme and the Share Incentive Plan, is that participation in those plans must be made available to all employees who meet certain statutory conditions and who are both resident and ordinarily resident in the UK. However, the changes to be made to the way in which employees who are UK resident but not ordinarily UK resident will be taxed in the UK as a result of the original draft of the Finance Bill required that participation in these plans (both of which are HMRC approved plans) be extended to include employees who are resident but not ordinarily resident in the UK. These changes could have impacted on companies operating these plans in two ways. First, to ensure that HMRC approval of the plans is retained, companies may have been required to make amendments to the rules of the plans. Second, companies intending to issue invitations to participate prior to the date of Royal Assent of the Finance Bill would have needed to consider whether participation should be extended to employees who are UK resident but not ordinarily UK resident if the grant of options or acquisition of shares pursuant to those invitations would have occurred after the date of Royal Assent. However, amendments have now been made to the Finance Bill with the effect that participation in the Savings Related Share Option Scheme and the Share Incentive Plan will not be required to be extended to employees who are resident but not ordinarily resident in the UK. Nonetheless, it may still be necessary for companies operating these plans to review the rules of the plans and make amendments to ensure that the company is not required to extend participation to UK resident but not ordinarily resident employees. This will be the case where, for example, the rules provide that invitations to participate must be issued to employees who are taxable under section 15 of ITEPA.

Restricted Securities As a result of the changes to be made in the Finance Bill, employees who acquire securities subject to certain restrictions (Restricted Securities), who are resident but not ordinarily resident in the UK will now be subject to the income tax regime which applies to employment-related restricted securities in Chapter 2 of Part 7 of ITEPA. As such, in certain circumstances these employees may wish to enter into a joint tax election under section 431 ITEPA on acquisition of their shares in order to limit the income tax liabilities which could arise in future in connection with those shares. To be valid, these elections must be entered into by the employee and their employing company within 14 days of the date of acquisition of the relevant securities. Although the residence rules in the Finance Bill will apply to restricted securities acquired on or after 6 April 2008 (other than restricted securities acquired on exercise of an option granted before 6 April 2008), until the Finance Bill receives Royal Assent, any shares acquired by non-ordinarily resident employees will not constitute restricted securities with the result that a section 431 ITEPA tax election made in respect of those shares may not be effective. However, as mentioned above, given that a section 431 election must be entered into within 14 days of the acquisition of the shares, there was a concern that employees who acquired shares during the period between 6 April 2008 and the date of Royal Assent could have been disadvantaged if they were unable to enter into a valid section 431 ITEPA election in respect of their shares. Amendments to the Finance Bill have addressed this concern with the result that employees who are resident but not ordinarily resident in the UK and who acquire restricted securities on or after 6 April 2008 and on or before 31 July  2008 will be permitted to enter into a valid section 431 ITEPA tax election in respect of those restricted securities at any time before 15 August 2008.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Graham Muir

Nabarro 

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UNITED KINGDOM

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