Operating an employee share scheme can potentially trigger a range of tax traps for the unwary. Equally, completing the annual unapproved share plan return (commonly known as Form 42) can be time consuming and easy to get wrong, especially in light of recent developments concerning internationally mobile employees.
Failure to submit the form on time, or correctly, can prove very costly as HMRC can apply a penalty of £300 per reportable event (e.g. option grant or exercise), as well as daily penalties. Whilst it has not historically sought to apply these penalties, HMRC has now allocated significant resources to share plan reporting, with a consequent increase in the number of share plan reviews undertaken.
Form 42 must be completed and submitted within 3 months of the end of the tax year. But HMRC no longer issues paper copies of Form 42 and so it is the employer’s responsibility to download the return, complete it and submit it by 6 July. Unsurprisingly, many companies struggle to meet this deadline with surveys citing reasons such as:-
- a lack of confidence that this return can be completed correctly;
- difficulty understanding which section of the form to complete: and
- a lack of internal resource available to complete the return
Given HMRC’s new risk-based approach, Form 42 compliance has become one of the tools used by HMRC to judge a company’s risk profile. Common questions that HMRC will consider are:
- Has the company submitted its returns correctly and on time?
- How many plans does the company operate?
- How complex are those plans?
- How many employees participate?
- Is the company a subsidiary of a foreign parent?
- Does the parent company administer the share plans from overseas?
- How many internationally mobile employees participate in share plans?
- Has the company completed any corporate transactions?
In light of HMRC’s increased focus on share schemes, and the potentially significant penalties associated with incorrect or late reporting, before completing the return employers should consider the following questions to determine whether they should request professional assistance to complete Form 42:
- Has the return been submitted on time in prior years?
- Has undue pressure been applied in order to meet the prior years’ reporting obligation?
- Have there been inconsistencies between employment and corporation tax returns and share scheme returns?
- Has PAYE/NIC been correctly applied to unapproved options/awards?
- Has PAYE/NIC been correctly calculated and reimbursed by the employee?
- Has employer’s NIC been transferred to employees and, has income tax relief been correctly applied?
- Has the overseas parent company notified all options exercised by UK employees?
- Have any approved options been exercised in an unapproved manner?
- Are processes sufficient to track internationally mobile employees who participate in share plans?
The following case studies highlight some of the complexities associated with operating share schemes. These gave rise to reporting errors, and generated additional liabilities to tax, interest and penalties.
Listed food manufacturer and wholesaler
The listed company’s UK subsidiary granted unapproved options to several UK resident employees who later relocated overseas before the options were exercised. Although the employees were employed by other group companies and were no longer UK resident, as the employer when the options were granted the UK subsidiary retained the obligation to apply PAYE on exercise. However, it was noted during an employer compliance review that it had failed to apply PAYE, and to report the exercise of these options on Form 42.
UK subsidiary of US listed company
Several UK directors were granted unapproved options directly from the USA without the UK company being notified. When the options were exercised the directors liaised directly with the US parent company, which was not aware of the UK reporting obligation and the need to apply PAYE and National Insurance to the share option gains.
The issue was uncovered during an HMRC review. HMRC proved that the UK company had failed to apply PAYE and NIC. A significant liability arose which was compounded by interest and penalties, as well as a ‘section 222’ charge, which arises when an employer fails to recover PAYE and NIC from the employee within 90 days.
UK listed manufacturing company
Prior to flotation the company granted unapproved options to its executive directors. Significant gains arose on flotation and the company applied PAYE and NIC on the gains accruing to the UK resident executives. But, it did not apply PAYE to the US resident director’s gains, even though he was a main board director and had certain UK duties. Although, the event was disclosed to HMRC and the tax was calculated and paid, an expatriate tax review was triggered. This took many years to resolve and highlighted other compliance failures, particularly regarding short term business visitors.
If any of these issues suggest that you would benefit from professional support to complete Form 42 or to review your employment tax compliance , we would be pleased to help you develop a plan to identify any risks and meet your reporting obligations.
