A bright Vermillion line for employee shares

The legislation for employment related securities (‘ERS’) outlines various tax anti-avoidance provisions related to shares and other securities held by employees and directors. The recent court case, ‘Vermillion Holdings’, has confirmed the broad applicability of these rules. 

As a result, more companies and employees need to be aware of the rules than initially thought.

Who are affected by the ERS rules?

Potentially any shareholder who is an employee, director and non-executive director of the company or group, even if they are a founder-shareholder. If you fall into this category, you should be aware of the avoidance rules and seek tax advice before buying, selling, or transferring shares. Like other tax-avoidance provisions, they can catch taxpayers out unexpectedly.

Taxing employee shares

At its most basic, employment tax arises when employees are provided something of value by their employer.
Shares and securities have long been used to deliver value to employees. There are many good reasons for this, including corporate governance and aligning incentives with stakeholder value. For these reasons, the government encourages employee share ownership, with various tax breaks available.

However, because shares and other securities are relatively easy to transfer and alter, they can be exploited to transfer value. This has led to the introduction of tax anti-avoidance provisions specifically related to shares. These provisions address the government’s views on how employment related shares should be subject to employment income tax. Various potential charges can apply, including selling them for more than the tax value of the shares (which can differ from the commercial value) or if actions are taken to increase the value of the shares (eg during a capital re-organisation). 

None of this is new. Legislation was introduced in 2003 to combat many of the ways employee shares were used for tax avoidance. However, it took 20 years until the ‘Vermilion’ case at the end of 2023 for the courts to clearly rule on the full scope of the legislation. 

This legislation applies to ‘ERS’, which most commonly refers to shares and loan notes but technically also covers several other financial instruments.

Employees and directors often acquire shares in their employer. However, caution is required when dealing with shares held by employee and directors, as there can be employment tax consequences due to the extensive tax anti-avoidance legislation. 

The Supreme Court’s analysis

The anti-avoidance provisions apply when an employee or director acquires shares (or other securities, eg loan notes) in their employing company while they are an employee or director. Unless the shares were acquired from an individual for personal reasons (friendship, family), they will automatically be deemed to be connected to the employment and fall within the scope of the legislation. Shares and securities within the scope of the legislation are called ‘employment related securities’ (‘ERS’).

As an example, founder-shareholders who become directors when their new company is set up are considered to have acquired the shares due to their directorship and are within the scope of the legislation. 

Even in those rarer cases where the deeming provisions don’t automatically apply (eg transfers from family members), the acquisition would still fall within the scope of the legislation if it was due to the employment. For instance, a transfer to the daughter of the main shareholder made because the daughter is a director (rather than for family reasons) is caught. 

Being associated with an ERS doesn’t necessarily mean an employment tax charge automatically arises, it simply means more care is needed.

If a share is considered an ERS, any benefits not related to normal capital growth or normal dividends could be subject to income tax (typically PAYE and National Insurance contributions, although the rules can be complex) on the value received.

Examples include value passing into employee shares from another shareholder (perhaps through changing the articles of association, or writing off a loan note) or an ‘employee’ selling their shares for more than the shares are worth (as determined for tax purposes).

Conclusion

As a result of the Vermilion case, we now have clarity to determine who needs to pay attention to this legislation:

Shareholders who are or were employees or office holders (directors, non-executive directors, company secretary) when you acquired shares in your employer/ its group could be subject to additional employment tax charges. The safe approach is to assume the employment tax avoidance provisions could apply to these groups of shareholders. There are some exceptions, but these are narrower than some had thought.

In these circumstances, we recommend you seek specialist advice.

For a conversation about employment related securities, please get in touch with Martin Brown or your usual RSM contact.