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Lex Loci Laboris lost

Category Technical Articles
AuthorTechnical Department
Policy on share options for expatriates loses sight of basic principles. Article by David Heaton who heads the Employer Consulting Group at Baker Tilly, published in the March 2002 issue of Tax Adviser. The lead article in Tax Bulletin 55 (October 2001) set out the Inland Revenue’s views on the double taxation issues around share options and ‘internationally mobile employees’, focusing on the treatment of unapproved share options, or non-qualifying exercises of options under a United Kingdom (UK) Revenue-approved plan. Tax Bulletin 56 (December 2001) has now expanded on those views with the lead article on liability to Class 1 national insurance contributions (NICs).

The views on NIC will have come as something of a shock to many international human resources (HR), payroll and tax professionals, as well as leaving them nonplussed about the questions it didn’t answer (further Tax Bulletin articles are expected) and how it complies with European Community (EC) social security regulations.

What’s the official view?

In summary, if an option is granted while an employee is resident and ordinarily resident (ROR) in the UK, any gain on exercise will be taxable in the UK under Sch. E even if the employee, at the time of exercise, has ceased to be UK resident and is no longer within any of the cases of Sch. E.

Abbott v Philbin (1960) 39 TC 82 established that the option, rather than the shareholding resulting from exercise, was the emolument. The section that is now Income and Corporation Tax Act 1988, ICTA 1988 s. 135 was introduced to move the occasion of charge to the point of exercise, and to render the gain subject to income tax, albeit without deeming the gain to be an emolument of any particular year. An option right granted by virtue of a UK employment remains within s. 135 even for employees who have moved overseas. Double taxation may occur because the employee is also taxable on exercise in the current host jurisdiction (which, in fact, may be his home jurisdiction if he has returned home after an assignment to the UK).


Tax Bulletin 55 explains that the Revenue will usually time-apportion on a straight-line basis the gain from grant to exercise where an employee:

  • was granted a share option in the UK during the course of an employment;
  • exercised that employment in the other country during the period between the grant and exercise of the option;
  • remains in that employment at the date of the exercise;
  • would be taxed by both of them in respect of the option gain; and
  • is not resident in the UK at the date of exercise.
Other methods may be applied provided ‘this does not produce double taxation or lead to income going untaxed in either country’. Having accepted the premise that the gain accrues evenly as a reward for work in the period between grant and exercise, some of which is during a period of non-residence, the UK Revenue does not make it clear why it should have the right to choose to tax someone in the UK in respect of work in another fiscal jurisdiction if the authorities there have chosen to make the gain exempt. What if the host state is Switzerland, which taxes options at grant rather than exercise, or Belgium, which takes the same line and furthermore doesn’t charge social security taxes on option gains? But that is another matter.

NIC treatment

The views on NIC are set out in Tax Bulletin 56, using the same basic tax principles as a starting point. However, they quickly become clouded by the impact of EC social security rules and bi-lateral reciprocal agreements, which automatically override domestic law. National insurance contributions on share options have been a problem since 1996, which a series of acts and regulations has tried to solve. The 1999 change to deem gains to be NICable earnings, a pure revenue-raising measure, does not sit well with NIC rules which were designed to provide social security benefits and seem to have disappeared from the view of the Revenue policy makers.

Short EC assignments

Even the simplest case of short-term assignment gives problems. The first example in Tax Bulletin 56 is a UK ROR employee, who is granted an option before assignment that is exercised while he is working in France for only a year. On the dates chosen, this will include parts of two fiscal years in both the UK and France. In the example he is ‘seconded’, suggesting that he remains under a single contract with the UK employer. He is therefore automatically kept in the UK NIC net by Art. 14(1)(a) of EC Reg 1408/71, and he remains taxable under Sch. E, Case I throughout. Easy (maybe): NIC the whole gain.

France will probably have the right to tax his income, and France taxes share option gains on exercise. France should accept an apportionment of the gain between UK and French periods of duty, in view of the fact that the option was granted before he started working there, but will this apply equally to tax and social security, which are subject to separate legal codes? How much of the gain is in fact ‘chargeable’ within the terms of ICTA 1988, s. 135? Do the French authorities accept the UK Revenue’s interpretation for social security purposes?

Longer EC assignments

Here the situation becomes even more complex in social security terms. The Tax Bulletin 56 example uses Peter, a UK ROR employee posted to the Netherlands for three years having been granted an option beforehand that he exercise while on assignment. The employee does not hold an E101 certificate under Art. 17, so he leaves the UK NIC system when he takes up the assignment and he ceases to be UK resident at the same time.

According to Tax Bulletin 56:

‘On the date of exercise Peter would not normally fall within UK legislation.

However, in 1997 the EC Administrative Commission concluded that a person should normally be subject to the legislation of the Member State where the income related to a period of employment in the Home State rather than be subject to the legislation of the Member State at the actual time of payment. As the gain on the share option was realised from a period of employment in the UK a liability to pay Class 1 NICs on that gain arises under UK legislation in the normal way.’

This prompts several questions:

  • what did the EC Administrative Commission (AC) actually conclude?;
  • did it have the vires to reach that conclusion?;
  • how and when was the decision published so that EU citizens and employing entities knew their rights and obligations?;
  • did the AC consider the tax issues, or at least the derivation of the income figures for social security purposes, in arriving at its conclusion?
The actual conclusion

The minutes of AC meetings are not normally public documents, but the Revenue has kindly made available the relevant extract to those who asked. It emerges that the discussion centred around ‘income from former employment’, with specific reference to redundancy payments. All delegations agreed that such income:

‘was a matter for the Member State competent at the time the income was generated, i.e., at the time of exercise of the professional activity in respect of which the payment had been made.’

It is not immediately clear from the minutes alone that the ‘conclusion’ has any bearing whatsoever on share option gains. In the two examples already mentioned and others in Tax Bulletin 56, the employment concerned was continuous. There is no ‘former employment’.

It is also far from obvious that the AC delegates would even have had option schemes in mind, since not all states regard option gains as income. As noted above, Belgium does not levy social security contributions on option gains, and at the time the AC discussion took place, the Netherlands taxed option gains at the time of grant if the grant was unconditional (on vesting if conditional), so they would be unlikely to constitute post-termination income. The then-current UK rules taxed discounted options at grant. The AC delegates from these three states at least would be unlikely to have known they were discussing share options.

Power to conclude

Then there is the question of whether the AC had the power to reach such a conclusion. It’s existence and working methods derive from Art. 80–81, EC Reg. 1408/71. It is the AC’s duty to deal with all administrative questions and questions of interpretation arising from the provisions of EC Reg. 1408/71 or from agreements or arrangements concluded thereunder.

Exactly what were the AC discussing? European Community Reg. 1408/71 does not impose charges, it merely determines (for present purposes) the legislation applicable to individuals. The principle that has underpinned EC social security coordination since the Community was founded is that of ‘lex loci laboris’, the law of the place of work: you are insured in the state where you work, unless an exception applies. Article 13, in Title II, states: '

  1. Subject to Article 14c, persons to whom this Regulation applies shall be subject to the legislation of a single Member State only. That legislation shall be determined in accordance with the provisions of this Title.
  2. Subject to Articles 14 to 17

    1. a person employed in the territory of one Member State shall be subject to the legislation of that state ….’
Various exceptions in art. 14– 17 then direct or allow coverage in an alternative state. Article 14c provides the only rule that allows for simultaneous coverage in two or more Member States, in the very restricted circumstances listed in Annex VII to the Regulation (those option-holding UK expatriate executives who also happen to be self-employed in farming in Germany need to know this).

So the AC may interpret the rules to help determine the legislation applicable to a person. It absolutely cannot decide the legislation applicable to a particular payment, since that is a matter for the domestic legislation once the competent state has been identified in accordance with Title II, and it has no power to overturn the basic principle that a person cannot be subject simultaneously to the legislation of two Member States. You either follow ‘lex loci laboris’ or you follow one of the exceptions, which results in affiliation to only one scheme.

It seems fairly clear that the AC cannot have intended to allow or suggest that dual liability can arise on share option gains. If there is only one employment, there is only one liability. If there are two or more employments, Title II determines the legislation applicable to the employee. If two employments are simultaneous, Art. 14(2) will determine the single competent state. If they are consecutive, Art. 13 will apply to each in turn.

The essence of coordination is to prevent fragmentation of contribution records and consequent loss of benefit entitlement. It is inconceivable that the incidence of a UK share option gain during a period of employment in another Member State should be able to lead to concurrent liabilities in both states. It may be argued that the liabilities are on separate items of income – the host state collects contributions on current salary while the UK collects NICs on the share option gain – but this contravenes all the principles of EC Reg 1408/71.

If an employee has two concurrent employments in two Member States, with related or independent employers, art. 14(2) determines the single state which is competent for contributions and benefits, to the exclusion of the other. Article 14d also deems the employee to be pursuing all his professional activity or activities in the competent state so that none of the income is ignored in arriving at contributions or benefits. If the regulation deals with this circumstance, where there are two regular sources of income, it must be far less likely that there could legally be separate liabilities in two Member States in respect of, in one state, a one-off gain on a share option and, in the other, on regular earnings?


Article 80(3) states that ‘Decisions on questions of interpretation … shall be unanimous. They shall be given the necessary publicity.’ Formal ‘Decisions’ are indeed given publicity, in the Official Journal and on the Eur-Lex website (e.g., Decision 162 on the conditions for eligibility for an E101 certificate under art. 14(1)). The present decision, allegedly covering share option gains, is described in the AC minutes and in Tax Bulletin 56 only as a conclusion, so it is presumably, technically, not a ‘decision’ in Community terms.

Given that the ‘conclusion’ was reached as long ago as 1997, it is surprising that it has taken until late 2001 for the impact on share option gains to be publicised so that employers can meet their obligations. In 1997, of course, option gains were only rarely subject to UK NIC, and then at the time of grant, so the profile of the issue will have been very low. It seems possible that nobody thought to publicise the issue in 1999, when the liability was switched from grant to exercise, but it seems much more likely that it was a non-issue requiring no publicity because the DSS and other ‘competent authorities’ knew that EC Reg 1408/71 would not permit dual concurrent liability where EC nationals were concerned.

Tax and the Administrative Commission

In most EC Member States, the tax and social security collection authorities are separate entities. The AC delegates are experienced civil servants whose main focus is the coordination of social security systems and protection of EC migrant workers’ rights to benefits. It is pure speculation, but it must be a fairly safe assumption that, even in the unlikely event that the AC thought it was discussing contributions on share option gains in 1997, no thought was given to tax rules.

Non-EC situations

Tax Bulletin 56 also gives examples of option gains arising to employees covered by the US–UK social security convention and those covered by no treaties. There are also questions arising from the fact that employees taxed in the UK only under Sch. E, Cases II and III are not within s. 135, which can lead to a different liability under ICTA 1988, s. 162 and, potentially a Class 1A liability, although the article is vague about the exact facts and circumstances relevant to determining such liabilities.

The Revenue seems more ready to follow the established interpretation of the US–UK treaty in Example 6 of the article. Here, a UK ROR employee is granted an option before she is sent to the US for six years, during which time she exercises the option. The gain is taxable under ICTA 1988, s. 135 and, following Tax Bulletin 55, will presumably be time-apportioned for tax between periods of UK and US duties.

Because the posting is longer than five years, the employee becomes liable solely to US social security taxes on arrival there, and the Revenue accepts that there is no Class 1 NIC liability, despite the ICTA 1988, s. 135 tax charge and the UK source of the option gain. This interpretation depends on the employment being treated as being a single, continuous contract, although it can be argued based on UK NIC rules (see, for example, Contributions Reg. 2001, Reg. 146) that the start of the new duties in the US is a separate ‘employment’.

The rules of the US–UK treaty and EC Reg 1408/71 are different in detail, but embody the same principle for this purpose. It is wholly unclear why the Revenue believes it is bound by the US–UK treaty to single-state liability, yet is entitled to demand UK contributions in equivalent circumstances within the European Union (EU) when EC regulations also impose single-scheme affiliation.


There are numerous uncertainties and arguably ill-founded views in the Tax Bulletin 56 article. It is far from clear that the official view accords with EC law, to such an extent that there is a suspicion that an AC ‘conclusion’ (whatever that means or is worth) on post-termination payments has been seriously misinterpreted and misapplied. A further statement from the Revenue would be welcome, summarising the agreements it has reached with other Member States and the US on the tax and contribution liability arising from share option exercises.

Lex loci laboris is an old and unexciting principle that probably needs to be updated (changes have been under discussion for some years), but it remains for now the bedrock of EC social security coordination. Perhaps it is so old and obscure that it has been lost from view, or perhaps the authors of the views in Tax Bulletin 56 were unaware of it. If the stated views are indeed policy, it will interesting to see how quickly a UK employer sees the Revenue in the European Court of Justice.

Technical Department
020 7235 9381

March 2002 by David Heaton


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