Employment Related Securities acquired for less than Market Value (Chapter 3C of Pt 7 ITEPA 2003)

Question 1

When is Chapter 3C most commonly relevant?

Answer 1

When shares are issued nil paid or partly paid.

Question 2

Whe does Chapter 3C apply?

Answer 2

When employment-related securities are acquired for less than their market value

Question 3

How does 3C apply to securities acquired for less than market value?

Answer 3

It treats the amount of the undervalue as a notional loan.

Question 4

In general terms, how is the notional loan under 3C computed?

Answer 4

It is, broadly, equal to the CGT market value of the securities, less any amount that the employee has actually paid for the securities, or been taxed in relation to the securities, but ignoring amounts that the employee is obliged to pay in the future.

Question 5

How is the notional loan taxed?

Answer 5

It is charged as an annual charge on notional interest, and a possible further charge when the notional loan is discharged.

Question 6

What is the usual result when an employee acquires securities for less than their CGT market value? Under what legislation?

Answer 6

There is a general earnings charge under section 62 of ITEPA 2003.

Question 7

Which takes precedence, a section 62 general earnings charge or the Chapter 3C? What is the result?

Answer 7

The section 62 general charge takes precedence. The result is that a charge under Chapter 3C is rare.

Question 8

When can a Chapter 3C charge become relevant (bearing in mind the general earnings charge under section 62 of ITEPA 2003)?

Answer 8

There are some circumstances where there is no general earnings charge, or the amount of the general earnings charge is less than the notional loan. In those circumstances, the Chapter 3C charge can become applicable.

Question 9

In what circumstances did Chapter 3C used to be applicable, but no longer is?

Answer 9

i) It used to be the principal provision for taxing options granted to non-residents.
ii) It also used to be the taxing provision which applied to deferred share purchase plans.

Question 10

Why is Chapter 3C no longer relevant to deferred share purchase plans?

Answer 10

Although still applicable, where such arrangements involve a 3rd party [I don’t know how often deferred share plans involve a 3rd party], then they are taxed under Part 7A of ITEPA 2003.

Further, although deferred share purchase plans are still in principle taxed under Chapter 3C, credit is given for amounts taxed under Part 7A, so in practice no tax arises under Chapter 3C.

Question 11

Which piece of legislation sets out that credit is given for amounts taxed under Part 7A, (so that in practice no tax arises under Chapter 3C)?

Answer 11

Section 446T(3)(f) ITEPA 2003

Question 12

Does Chapter 3C apply to securities acquired by someone other than the relevant employee, by reason of the employee’s employment? Under what section?

Answer 12

Yes. Section 421B(1) ITEPA 2003

Question 13

Can a share be issued when it is not fully paid up?

Answer 13

No.

Question 14

If the outstanding loan is partly paid off, what is the tax effect?

Answer 14

If the employee makes further payments for securities, this will reduce the amount of the outstanding notional loan (section 446T(4) ITEPA 2003).

Question 15

Where an employee receives (a) nil-paid share(s), which has a CGT market value of £1, and a nominal value of 10p (nominal value and CGT market value remain unpaid by the employee, but the share is credited as fully paid up), what are the tax consequences?

Answer 15

There is a general earnings tax charge on the unpaid nominal amount of 10p per share, followed by a nominal loan on the 90p to which the notional loan annual charge will apply.

Question 16

Does Chapter 3C apply to securities which are not as a matter of fact acquired by reason of employment, but which are deemed to be employment related by section 421B(3) (Securities or interest made available by the employer or a connected person)?

Answer 16

Yes

Question 17

What is an example of 3C applying to securities which are not as a matter of fact acquired by reason of employment, but which are deemed to be employment related by section 421B(3)?

Answer 17

Where a director of a company is also a partner in a partnership that invests in that company. The individual might as a matter of fact acquire shares as a partner, but will be deemed to acquire them as a director.

Question 18

What is the likely tax result where a director of a company is also a partner in a partnership that invests in that company?

Answer 18

These will be deemed to be employment related by section 421B(3), and will be deemed to have acquired them as a director regardless of their position as a partner.

There can be no general earnings charge in relation to such securities, do if the employee acquires them for less than their CGT market value, there will be a Chapter 3C notional loan.

Question 19

Where Chapter 3C applies, how is the notional loan taxed? What is the implication?

Answer 19

It is taxed as it it were an interest-free employment-related loan. This means that the employee will be treated as having received additional income equal to the amount of interest they would have paid, had they been charged HMRC’s official rate of interest of the notional loan.

Question 20

Which legislation sets out that a notional loan will be treated as if it were an interest-free employment-related loan?

Answer 20

Section 446S (importing section 175 ITEPA 2003).

Question 21

Does the annual charge on notional interest cease when employment ends? (What section sets out the position on this?)

Answer 21

Yes. (Section 446S(2) ITEPA 2003.)

Question 22

Can there be a charge on the write off of the loan? (What is the legislation?)

Answer 22

Yes, according to HMRC guidance (ERS70130). But, this will only apply if this happens within seven years of cessation of employment. The reason for this is that after seven years, the shares are no longer treated as employment-related securities (section 421B(7) ITEPA 2003.

Question 23

What are the three possible outcome in terms of disposal of “undervalue shares” and the notional loan being discharged?

Answer 23

1) The securities are disposed of, but the notional loan is not discharged
2) The notional loan is discharged but there is no income tax consequence.
3) The notional loan is discharged and there is an income tax consequence.

Question 24

When will the notional loan interest charge come to an end?

Answer 24

1) When the employment ends
2) The shares have been disposed of to an associated person, and there is a subsequent disposal to a non-associated person, in a manner which causes it to be discharged
3) If the shares have been disposed of to a non-associated person and the employee (or an associated person) retains the liability to make a payment on the shares, when payment is made in connection with the disposal

Question 25

In what events will a notional loan not be discharged but continue to exist?

Answer 25

1) The securities are disposed of to an associated person.
2) The securities are disposed of:
- to a non-associated person;
- where, at the time of the acquisition, there was an actual or contingent liability to make one or more further payments equal to the amount initially outstanding on securities; and
- that liability remains with the employee (or an associate).

Question 26

Which legislation dictates that a notional loan is not discharged but continues to exist if securities are disposed of to an associated person?

Answer 26

This is the case because section 446U(1)(a) does NOT apply to such a disposal.

Question 27

Where securities are disposed of to a non-associated person where there was a contingent liability to make one of more further payments equal to the amount initially outstanding and that liability remains with the employee (or an associate), what is the tax position and what legislation applies?

Answer 27

1) The notional loan will not be discharged

2) Section 446U(1)(a) is disapplied by section 446U(1A)

Question 28

If a notional loan does not come to an end for one of the three reasons, what happens to a notional loan?

Answer 28

It will, in principle, continue indefinitely.

Question 29

In how many different circumstances will there be an income tax charge under section 446U of ITEPA 2003?

What are these?

Answer 29

3

1) The securities are disposed of to a person who is not associated with the employee (but not where, at the time of the acquisition, there was an actual or contingent liability to make one or more further payments equal to the amount initially outstanding on securities)
2) The employee is relieved of any obligation to pay up any outstanding amount on the shares (other than on the employee’s death (see Death)) (but not where the securities are transferred to a non-associated person who takes on the liability to pay up the outstanding amount, and where the price reflects the transfer of the liability)
3) Something is done to the securities as part of a tax avoidance or NICs avoidance arrangement

Question 30

What will be the taxable amount in relation to any charge under section 446U ITEPA?

Answer 30

Any amount remaining of the notional loan before the chargeable event (section 446U(2) ITEPA 2003).

Question 31

If one of the main purposes of an acquisition of securities is the avoidance of tax or NICs, what is the tax result?

What is the legislation?

Answer 31

There is an immediate income tax charge on what would otherwise be the amount of the notional loan.

Section 446UA ITEPA 2003.

Question 32

What are the exclusions from Chapter 3C?

Answer 32

1) Death
2) Seven years after cessation of employment?
3) No charge if majority of share class not employment-related or if the class confers employee control
4) No notional interest charge on shares if employee would receive tax relief for a loan to acquire the shares
5) De minimis exemption

Question 33

Is there a de minimis exemption as regards notional loan interest charges?

Answer 33

Yes

Question 34

What legislation sets this out the de minimis exemption as regards notional loan interest charges?

Answer 34

Section 446S, importing section 180, ITEPA 2003.

Question 35

What is the de minimis exemption as regards notional loan interest charges?

Answer 35

This applies where an individual employee’s actual and notional loans together do not exceed £10,000.

Question 36

If an employee is an internationally mobile employee, what is the effect?

Answer 36

Part or all of the taxable amount under Chapter 3C may be excluded from UK taxation.