Three’s a crowd: HMRC’s approach to employee share plan arrangements in practice

We have seen a notable rise in HMRC targeting what may be regarded as relatively innocuous employee share plans under the so-called “disguised remuneration” rules in Part 7A of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

Part 7A ITEPA is anti-avoidance legislation that was introduced in 2011 principally to target employee benefit trusts and other similar arrangements that give employees or their families access to what is in reality employee remuneration in a way that avoids or defers liabilities to income tax and NICs.

In summary, Part 7A will apply (through the “main gateway”) where a “relevant third person” (someone other than the employee or employer) takes a “relevant step” (e.g. “earmarking” amounts, making a loan, transferring an asset, etc) that is in some way connected to a “relevant arrangement” (meaning that it wholly or partly relates to an employee or a person linked to the employee, or the employee or person linked to the employee is a party to the arrangement) which is concerned with the provision of rewards, recognition or loans in relation to the employee’s employment.

The rules are broadly drawn and it is important to bear them in mind whenever a third party is involved in an employee’s remuneration arrangements, even if their involvement appears tangential.

However, the rules were introduced for a purpose and they require that “all relevant circumstances are to be taken into account in order to get to the essence of the matter” (s.554A(1)). They should not, therefore, apply to employee share plan arrangements where the involvement of a third party is not related to any tax avoidance motive.  

That view was endorsed by the First-tier Tribunal in the case of Root 2 Tax Limited v HMRC [2019] UKFTT 744 which stated [at paragraph 321(2)]: 

“it is unlikely that Parliament intended to capture within these provisions, as a payment of a sum of money, a movement of monies from one person to another where in substance there is no economic gain for the recipient. The whole tenor of these provisions, broadly drawn as they are, is to capture sums which are in reality paid by way of economic gain as disguised employment earnings.”

What we have been seeing more recently, however, are challenges by HMRC in circumstances where there is any noteworthy third party involvement. For example, where shares come to be acquired by another company or are held in trust, even if those third parties are unrelated to the remuneration arrangements and do not affect what would otherwise represent a typical employee share arrangement. This has included occasions in which HMRC are imposing tax by reference to a sum that exceeds the amount that could be realised by the relevant employee. 

Any approach that extends beyond the mischief that the Part 7A rules were designed to address and casts doubt on well-worn employee share arrangements is concerning. The mere fact that shares in a company are held by a third party on behalf of an employee or that there is some other act taken by a third party, in circumstances where there is no obvious tax avoidance aspect, should not trigger the Part 7A rules.

It is therefore hoped that HMRC ultimately take the view that Part 7A (quite properly) should not apply to commercially motivated share purchase arrangements involving third party participation and, if necessary, this would be supported by the Tribunal in any future appeals. For the moment, however, employers and employees would be well-served to reflect on any arrangements they are planning that involve third parties in order to ensure that they are robust.