Employment Related Securities (ERS)
The term Employment Related Securities (ERS) means that the shares or securities in question are acquired in connection with an employment.
The term securities is defined in the legislation but is quite broad and includes shares, debentures, loan stock and financial instruments such as options, futures and other contracts.
What are the issues associated with employees acquiring shares?
When employees acquire shares or securities without paying market value there is an exposure to income tax charge based upon the market value of the shares or securities received.
The employment-related securities (ERS) rules seek to modify the position in cases where the tax consequences, that would in the absence of the ERS rules, would not reflect the full economic value received, or in specific circumstances where the Government intends a more favourable tax treatment to apply.
What does this mean practically?
In practical terms, this means that anyone who establishes a company and becomes a director of it will be treated as having acquired employment related securities.
Shares that fall within the ERS regime can be acquired in many ways such as:
- Unapproved share options;
- Approved share options e.g. EMI
- Certain share for share transactions
Are there any exemptions?
The only exemption from the regime is where an individual (A) acquires shares either from:
- an individual (B) or
- close company that is controlled by that individual B
and has acquired them in the course of a domestic, family or personal relationship.
A close company is broadly a company controlled by five or fewer shareholders or any number of directors. Typically, in practice this means most SMEs/owner managed businesses.
Surely employees can acquire shares while the value is low?
There are specific rules to target situations where the value of a share is artificially depressed for acquisition e.g. by having certain rights or restrictions attached to it or where the share can be converted into another form of security at a future date.
There are also anti-avoidance measures to cover situations where the value of shares is artificially depressed or enhanced by other than commercial means.
Most shares in a private company will have a depressed value for various reasons e.g. restricted transfer rights
Restricted securities can be subject to income tax charges in a number of scenarios:
- On the acquisition of the shares, the charge to income being the difference between the restricted market value of the shares and the price paid;
- On the date the restrictions are lifted, with income tax being charges on the proportionate difference between the unrestricted market value less the unrestricted value which has already been assessed to income tax; and
- On the sale of the securities if the restrictions have not been lifted.
The risk is that when restrictions are lifted, the proportionate difference between the Unrestricted Market Value and the Restricted Market Value may be significant due to the shares having increased in value. The individual can then suffer an income tax and potentially NIC charge on a proportion of any gain on sale.
This can be avoided by the employer and employee signing a joint s431 election to disapply all restrictions which means that the value subject to income tax at the time the shares are acquired will be the difference between the Unrestricted Market Value and the price paid.
The advantage of this is:
- There is only one charge to income tax i.e. at acquisition; and
- The growth in value from acquisition is subject to CGT not income tax – this could mean tax at 10% (if Entrepreneur’s Relief applies) or 42% if not (Income Tax plus NIC)
It is important to take advice when employees are acquiring shares so that any income tax exposure is minimised. EMI schemes can be a great way of incentivising employees whilst keeping the acquisition cost of shares low (and avoiding any income tax charges too). I have extensive experience implementing EMI schemes.
Alternatively, where a business is of significant value, and shares could not be acquired affordably by employees, another route is a growth share scheme. Here, the basic principle is that the employee acquires a share for low/nil cost and only participates in the growth from that point. This is achieved by the shares having a capital hurdle i.e. no right to participation until the hurdle is surpassed.
At ETC Tax we have extensive experience working with our clients to help incentivise their employees and/or Directors.
It is imperative that before such a scheme is implemented that careful advice is sought with regard to valuation to minimise any tax exposures.
Disclaimer: Please note this is just a very brief summary of the common issues. It is by no means an exhaustive guide to ERS and does not constitute formal advice.