Changes to UK corporate tax regime in relation to employee stock plans

On November 27, 2002 the Chancellor announced in his Pre-Budget Report ("PBR") the introduction of a statutory corporate tax deduction for the costs incurred by companies in connection with the operation of their employee equity-based plans.

Which incentives will be affected?

The draft legislation is not yet available, but based on meetings with the Inland Revenue, PwC anticipates that the statutory deduction will be available for options exercised and other awards vesting (such as restricted stock) in accounting periods starting on or after January 1, 2003. The deduction is likely to be available only for plans where the employees are subject to UK tax on an award of shares (or would be but for the fact that the shares were awarded under an Inland Revenue approved plan or an enterprise management incentives plan). Thus, a deduction would seemingly be available for options granted under UK approved sub-plans.

It is anticipated that the legislation will apply to benefits provided in the form of "qualifying shares." These are fully paid up, non-redeemable, ordinary shares meeting conditions broadly as follows:

  • they must be shares in the employing company, or a company which controls it, or a company which is a member of a consortium which owns either of these; and
  • they must be shares listed on a recognized Stock Exchange, or shares in a company controlled by a listed company, or in a company not controlled by any other company.

Most shares awarded under US equity-based plans fulfill these conditions under normal circumstances.

What will be the amount and timing of the deduction?

Again, based on previous discussions with the Inland Revenue, we anticipate that the deduction will be available for the difference between the market value at exercise and the price paid by the employee to acquire the shares (the "spread"). It is also likely that the deduction will be available at exercise/vesting.

At present, corporate tax deductions are generally available on an accrual basis. This will be changed such that the deduction will only be available at the time that the employee is taxed (i.e. at the time of exercise in the case of stock options).

In the event that an option is never exercised or an award never vests (for example, because the employee leaves, the option is underwater or performance conditions are never met) a corporate tax deduction will never be available under the proposed regime.

As mentioned above, this is a divergence from the trend in recent years of matching corporate tax deductions to the accounting treatment and has a result of delaying the availability of any deduction available under current principles.

Will this have any impact on options exercised/awards vested prior to January 1, 2003?

Recently the "Waterloo" case addressed the treatment of recharging for stock option plans. The Waterloo case highlighted the validity of a charge by a parent to an employing subsidiary for the provision of an employee equity-based plan. Many US companies have generally recharged their subsidiaries the full “spread” (i.e. difference between fair market value at exercise, and the option exercise price). Following Waterloo, the Revenue considers that such agreements are not at not arm’s length. The Revenue favors a deduction based on a hedging (typically a Black-Scholes) approach, deducted at grant.

As a result, where the Inland Revenue inspectors have not already agreed deductions, we can expect that deductions on a full spread basis will be challenged for open past periods, and for periods until the new legislation becomes effective. The Inland Revenue is not expected to release any further guidance on this issue until February 2003.

What should I do now?

It is important that you do not determine your immediate incentive policy on the assumption that the statutory tax deduction, on the basis set out in the PBR, will be available in January 2003. We recommend that you wait until more details are available on the nature of the relief. Once additional guidance is available, it will be appropriate to review your chargeback policy.

For more information about any of this development, please feel free to contact any of our team members listed below.

Carine Schneider (Partner) / (415) 498-5916
Julie Rumberger / (415) 498-5462
(408) 817-4162
Deborah Luby / (415) 498-5621
Siobhan Hurley / (415) 498-5366
Bill Dunn (Partner) / (267) 330-6105
Jill Hemphill (Partner) / (267) 330-6275
AmyLynn Flood / (267) 330-6274
Geoffrey Hammel / (267) 330-6331
Aaron Sanandres / (646) 394-4605
Aldona Gorman / (646) 394-4298
Jason Overmier / (720) 931-7259
Allison Scott / (407) 236-5156

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