Revenue answers to recent questions from the Personal Taxes Sub-Committee on Schedule 22 Finance Act 2003
On 8 September 2004 we wrote to the Revenue for some clarification on the impact of Schedule 22 on company takeovers. We have now received a reply and the text of our queries and the Revenue’s response is given below.
Our Finance Bill 2003 representation was based on the following example (slightly modified). We would also be grateful for your views on a small variation to the example.
An employee invests £1,000 in ordinary shares in a start-up company in 1999. The shares are acquired by reason of employment and, on acquisition, are worth £1,000. In October 2003, a takeover offer is received from a listed company at a time when the employee's shares in the start-up company are worth £1,000,000. The employee receives £900,000 of shares in the listed company and is prohibited from selling them for one year. This "lock-in" condition is imposed to ensure that there is an orderly market for the listed shares. If there had been no such condition, the shares in the listed company would have been worth £1,000,000. The employee (who is a senior executive) is temporarily "giving up" £100,000 of value but he is not concerned by this, as he fully intends to hold on to the shares for at least a year. Employees below senior executive level are not required to submit to the lock-in condition and, therefore, exchange their shares on an "equal value" basis.
This is the same as in the first example, except that the shares in the start-up company are acquired in 2004 and the takeover by the listed company occurs in, say, 2006.
First example – possible answer
In our view, the employment income tax implications of the first example are as follows:
1(i) The listed company shares fall within ITEPA 2003 s462 as originally enacted (see FAQ 2(cc)) and, accordingly, remain vulnerable to a charge to income tax under old ITEPA 2003 s450(3)(a) (removal or variation of a restriction), which (with other parts of old Chapter 4) is preserved by FA 2003 Sch 22 para 9(3)(a);
1(ii) The "lock-in" restriction will be removed by effluxion of time. In relation to old Chapter 4 (and FA 1988 s78 and s80 which preceded it), the Revenue's practice (in their press release of 14 April 1988 and in SSM 5.22) was (and presumably still is) that FA 1988 s78 and FA 1988 s80 did not apply to the removal of restrictions by effluxion of time, as those sections did not apply where an embedded right or restriction was varied or removed automatically according to its original terms. Consequently, the automatic removal of the "lock-in" restriction by effluxion of time in the above example will not give rise to an income tax charge under old ITEPA 2003 s450(3)(a).
In summary, therefore, although there is a potential tax liability under old s450(3)(a), this will not apply because the “lock-in” restriction is removed by the effluxion of time.
Second example – possible answer
In our view, the employment income tax implications of the second example are as follows:
2(i) Although the start-up company shares are acquired by reason of employment for the purposes of ITEPA 2003 Part 7, the listed company shares are not acquired by reason of employment for those purposes. They are acquired in the employee's capacity as a vendor shareholder in the start-up company;
2(ii) ITEPA 2003 s421B(3) does not deem the listed company shares to be acquired by reason of employment for the purposes of ITEPA 2003 Part 7. Section 421B(3) would only apply if the listed company acquired control of the start-up company (thereby becoming connected with it), and subsequently made a right or opportunity available to the employee to exchange his start-up company shares for shares in the listed company. We think this is a most unlikely order of events. In practice, we believe that the right or opportunity to exchange the employee's start-up company shares for shares in the listed company will invariably be made available to the employee before the listed company acquires control of the start-up company;
2(iii) ITEPA 2003 s421D(1)(a) does not deem the listed company shares to be acquired by reason of employment for the purposes of ITEPA 2003 Part 7. Section 421D(1)(a) is concerned with share conversions and similar capital reorganisations within a company. It is not concerned with the takeover of one company by another. Although the reference to "any other transaction" seems wide, it must in fact be limited by reference to the earlier reference to "conversion". If "any other transaction" is self-standing, why did the draftsman refer to "conversion"? He could just have said "any transaction" and that would have covered "conversions" and everything else;
2(iv) If the timing of events is such that ITEPA 2003 s421B(3) does deem the listed company shares to be acquired by reason of employment for the purposes of ITEPA 2003 Part 7, then Chapter 2 of Part 7 (restricted securities) is potentially in point. However, as the employee exchanges shares in the start-up company worth £1,000,000 for restricted ("lock-in") shares in the listed company whose initial unrestricted market value is also £1,000,000, he has nothing to fear from the restricted securities regime (whether or not he makes a s431 election). Each of IUMV and DA is £1,000,000. IUP is nil. Consequently, the taxable amount on the removal of the restriction at the end of the lock-in period will also be nil.
Therefore we consider that there is no charge to tax under Schedule 22.
We agree with your conclusion.
Whether the shares in your example are employment-related securities, or could be deemed to be so, is academic because, as you rightly conclude, there is no charge to tax under Schedule 22. The old shares have a market value of £1m. They are disposed of in return for new shares that have an AMV of £900,000 and a UMV of £1m. The consideration given for the new shares will be the market value of the old shares given up - £1m. If this consideration is applied in the formula in Chapter 2 there will be no charge when the restrictions on the new shares lift. The consideration given for the shares is equal to the UMV of those shares and there is no proportion to be taxed later.
Whether shares are employment-related securities under the new legislation is something that will depend on all the facts and circumstances in the particular case. A key fact, for example, – and one missing from your example – would be whether the employee will continue in employment with the new company.
The Revenue also say that they will take these points into account when writing their guidance.
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