Corporation tax relief for share-based payments not a done deal

18 November 2023

Employers that choose to incentivise staff by offering rewards that are linked to the company’s shares might expect to receive similar tax relief as those that provide cash bonus schemes of equivalent value – after all, employee share ownership has been recognised as way to boost economic growth by a succession of UK governments.

It is unsurprising, then, that where shares are provided to employees for less than their market value, whether by way of a simple award, or an option or restricted stock unit (RSU) arrangement, the UK’s corporation tax code provides for a ‘statutory’ deduction (ie a deduction not linked to any underlying accounting entries). What is perhaps surprising is how difficult it is to determine the tax relief that is available in some relatively common scenarios, as recently updated HMRC guidance demonstrates. 

Specific issues identified in HMRC’s guidance

Over the summer, HMRC updated guidance on the tax treatment of two specific types of transaction that can occur where share options (a term which includes, for this purpose, RSUs) have been issued to a company’s employees. These are:

  • cash cancellation – where a cash payment is made to the employee in return for their options being cancelled; and
  • net settlement – where the company does not issue a proportion of the shares under option (typically equal in value to the employee’s liability to employment taxes if the option were exercised in full) and the employer instead settles the employment tax liability on the employee’s behalf.

The key issue that the guidance draws attention to is that the statutory deduction does not apply where shares are not actually acquired. In the case of cash cancellation, this means that no statutory deduction is available at all. In the case of net settlement, the statutory deduction is limited to the shares that are actually acquired, and provides no relief for the tax paid on the employee’s behalf (although, other, economically similar, ‘sell to cover’ arrangements may not be subject to the same restriction).

All is not lost, but it does get more complicated

A 2022 decision of the Supreme Court in the case of NCL Investments demonstrates that, just because the statutory deduction does not apply, this does not necessarily mean that the employer gets no tax relief at all in respect of the share-based payment arrangement. Relief may instead be available under general tax computational principles for the associated accounting debits that are recognised in the profit and loss account.

However, the interaction of the complicated accounting rules governing share-based payments and the general tax rules can be problematic. For example, there may be circumstances in which accounting standards require certain amounts to be debited directly to reserves rather than to the profit and loss account, meaning they may not be taken into account for corporation tax purposes.

Furthermore, there is a tax rule providing that, where options or RSU’s do not result in an award of shares, a general principles deduction will only be available to the extent that the relevant amounts are charged to employment taxes as earnings. Although cash cancellation and net settlement will normally result in employment tax liabilities, this rule can cause a timing issue as, for accounting purposes, the relevant share-based payment expense will be spread over the vesting period of the arrangement, but the employment tax charge arises only when the cash cancellation or net settlement payment is made. HMRC says that no corporation tax relief can be claimed until that point, by which time the company may, depending on the circumstances, be out of time to take relief for the accounting expenses that were recognised in earlier periods. 

What this means

Companies with share-based payment arrangements should keep the tax consequences under review, particularly where the statutory deduction is likely to be unavailable or restricted. This will be the case for cash cancellation and net settlement arrangements, and potentially in other circumstances – for example, where the company whose shares are under option is under the control of another company.

The accounting analysis, and in turn the corporation tax treatment, may be very sensitive to the precise facts of the arrangement, and HMRC’s guidance indicates that it will be taking a strict approach to applying the law, rather than offering taxpayers any pragmatic concessions. The updated guidance suggests that the corporation tax treatment of share-based payments may come under increased scrutiny, so we recommend liaising with advisers at an early stage to ensure there is time to arrive at a robust filing position to maximise any deductions available.

For more information, please get in touch with Suze McDonald or your usual RSM contact.