The UK Government has included two important changes to corporation tax relief in the draft Finance Bill 2014, both of which are expected to come into force later this year. The changes allow corporation tax relief to be claimed on the exercise of employment-related options following a takeover, and extend the availability of corporation tax relief to situations involving overseas employers.
Under Part 12 of the UK Corporation Tax Act 2009 (Part 12), companies can claim corporation tax relief when one of their employees acquires shares in the company. For relief to apply, the shares must be acquired because of the employment, or be acquired pursuant to the exercise of an option that was acquired pursuant to the employment.
In the absence of restrictions or conversion rights in respect of the shares, the level of relief available to the employing company is equal to the market value of the shares at the time when they are acquired by the employee, less the total of any consideration paid in relation to the acquisition of the shares and, where relevant, the option (e.g. an option strike price).
Change of Control
Currently, the acquired shares must be shares in a listed company, a company that is controlled by a listed company or a company that is not under the control of another company for them to qualify for the relief.
Currently, therefore, when a company is taken over by an unlisted or an AIM-listed company, any employee share options exercised following the change of control will not give rise to corporation tax relief under Part 12.
In practice, this has meant that, where possible, options must be exercised prior to a takeover being completed to ensure the availability of the statutory corporation tax relief deduction.
The Finance Bill 2014 changes this by providing that any corporation tax relief that would have been available immediately before the change of control will continue to be available, provided the options are exercised within 90 days of the takeover. The legislation also provides that the takeover must not have the avoidance of tax as its main purpose (or one of its main purposes) if the 90 day grace period is to be available.
It is expected that this change will come into force when the Finance Act 2014 receives Royal Assent.
Changes in Relation to Overseas Employers
Under the current rules, the Part 12 corporation tax deduction is only available to employing companies, i.e. the companies with which the employee in question actually holds his contract of employment. In practice, this means that even if shares or options are awarded by reason of a UK employment in a commercial sense, e.g., based on UK activities, and the employee is charged to income tax in respect of the award of shares or the exercise of the options, Part 12 relief will not be available if the employee is legally employed by an overseas entity.
The Finance Bill 2014 will change this by extending relief under Part 12 for UK companies, and overseas companies that are within the charge to UK corporation tax, where share options are exercised by a person who works for the company, but is legally employed elsewhere, e.g., a secondee from overseas.
The Part 12 relief is limited to the amount of employment income on which the individual employee is charged to UK income tax in relation to the acquisition of the shares.
This change is expected to come into force from 1 September 2014.
Both these changes will be warmly welcomed. They reduce potential complexities for companies whose shares are under option at the time of a takeover by increasing the likelihood that Part 12 relief can be secured. They also provide opportunities for employers to incentivise their employees in a manner that is tax-efficient for the employing company.
The 90 day grace period now also neatly dovetails with the corresponding grace period for exercise of tax-favoured Enterprise Management Incentive options following a takeover.
Robert Coward, a Trainee Solicitor in the London office, has also contributed to this article.