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June 2010 Budget: capital gains tax reforms: implications for employee share incentives
Practical Law UK Legal Update 8-502-5893 (Approx. 4 pages)
June 2010 Budget: capital gains tax reforms: implications for employee share incentives
by��PLC Share Schemes & Incentives
| Published on 22 Jun 2010 • England, Wales |
A legal update about the changes to capital gains tax announced in the June 2010 Budget and their implications for employee share and share option plans.
Speedread
The June 2010 Budget included an immediate rise in the rate of CGT from 18% to 28%, for taxpayers with combined income and taxable gains above the income tax basic rate band, together with an increase in the lifetime allowance for entrepreneurs' relief from £2 million to £5 million. Otherwise, CGT remains substantially unchanged. The increased CGT rate reduces by 10% the differences between the CGT rate and the 40% and 50% rates of income tax. However, the change seems unlikely to reduce the popularity of either tax-favoured share options, or arrangements for employees to secure capital gains tax treatment of the growth in value of interests in shares or other securities, especially when National Insurance contributions liabilities on earnings subject to income tax are taken into account.
CGT reforms
In the June 2010 Budget, the chancellor announced substantial, but relatively simple, immediate changes to capital gains tax (CGT), fulfilling commitments made in the governing parties' coalition agreement (see Legal update, Tax under coalition government set to include big rise in CGT rate). This was probably the budget announcement of greatest relevance and interest to share schemes advisers. The proposal to reform CGT rates had been the subject of considerable speculation and lobbying before budget day.
Taxable capital gains on disposals made on or after 23 June 2010 will be taxed:
- At the current rate of 18%, to the extent that the taxpayer's total income and gains for the year fall within the income tax basic rate band.
- At a new CGT rate of 28% for gains (or any part of gains) falling above the income tax basic rate band.
- At 28% for disposals by trustees.
The CGT annual exempt amount (AEA) for 2010 -11 remains unchanged at £10,100.
Indexation has not been restored.
The lifetime allowance for entrepreneurs' relief increases for disposals on and after 23 June 2010 from £2 million to £5 million, but no other substantial changes to entrepreneurs' relief were announced (for more information on entrepreneurs' relief and employee shares, see Ask the team: Entrepreneurs' relief on a share sale (part one)).
The budget included no new special CGT provisions for employee shares or share options. Entrepreneurs' relief is available to employee shareholders in certain circumstances, but the requirement to hold at least 5% of the votes and the ordinary share capital of the employer for at least a year before disposal means that many employee shareholders are unable to benefit (in contrast to the special rules for shares acquired on exercise of EMI options under the former taper relief regime).
Legislation to enact these CGT changes is expected in a forthcoming Finance Bill expected before Parliament's summer recess. For more information on the CGT changes, see June 2010 Budget: key business tax announcements: CGT rises to 28% and entrepreneurs' relief to £5 million.
Significance of CGT changes for employee share and share option plans
Before the June 2010 Budget, there was a large (32%) difference between the highest income tax rate (50%) and the flat rate of CGT (18%). The effective difference was even greater for income liable to employee and employer National Insurance contributions (NICs), which was of particular significance for employees where employer NICs liabilities were borne by the employee.
The gap between the top rate of income tax and the CGT rate increased the benefits and attractiveness of:
- Tax-favoured employee share options (CSOP, SAYE and EMI) and HMRC-approved share incentive plans.
- Arrangements for employees to secure capital gains tax treatment on the growth in value of interests in shares or other securities, including:
- Growth shares (see Practice note, Growth shares and hurdle shares).
- Shared growth/joint ownership arrangements (JSOPs) (see Practice note, Joint ownership arrangements: an overview).
- Carried interest arrangements in private equity transactions (see Practice note, HMRC/BVCA memoranda: management interests in private equity and venture capital).
Obviously, a large increase in the CGT rate will reduce the net benefit realised by employees from employer shares and other securities, especially shares acquired under tax-favoured CSOP, SAYE and EMI share options (where income tax often does not arise on exercise, but CGT arises on disposal of the shares acquired on exercise). (The benefits of HMRC-approved share incentive plans are less sensitive to the CGT rate, as CGT is not charged on gains which accrue while employee shares are held in a SIP trust.)
However, although the CGT changes in the June 2010 Budget have significantly reduced the gap between the higher (40%) and additional (50%) rates of income tax and the new higher rate of CGT, the difference is still marked (12% for a higher rate taxpayer or 22% for an additional rate taxpayer and substantially more when NICs are taken into account). Tax-favoured share options remain attractive, as do growth shares, JSOPs and carried interests, subject to the forthcoming HMRC review of the tax treatment of "geared growth" arrangements (see Legal update, June 2010 Budget: Review of tax treatment of growth shares, JSOPs, carried interest and similar arrangements).
For many employees with capital gains on employer shares, the AEA and the possibility of using "no gain, no loss" transfers to a spouse or civil partner to minimise CGT liabilities will continue to offer relatively significant CGT savings.
For employees likely to realise larger gains, other routes to CGT planning will become more important. It seems likely there will be an increased focus on structuring executive equity interests to secure the benefit of entrepreneurs' relief for key figures in trading companies in which a 5% holding by an executive is not completely out of the question.