PAYE on employee shares
19th August 2022
Posted in Articles by Michael Hodgson
The issue
Usually, when employees are awarded shares, they will have to assess themselves to tax on any value that they receive through the medium of their tax returns. However, when the shares are treated as ‘readily convertible assets’ (RCAs) then PAYE will need to be operated in respect of them and income tax and national insurance will be payable. This can be the case when either there is a ready market for the shares, or if shares have been issued in a company which is under the control of another company (when the shares are deemed to be RCAs).
If care is not taken with reporting and paying the associated tax liability, the employee can be left with an unwanted 64% tax charge, due to what some people refer to as ‘the s.222 trap’.
The s.222 trap
Employers are allowed to make deductions from the employee’s net pay to cover their income tax and NIC liabilities arising on the award of shares. When the value of the shares results in a significant tax charge, it is likely that the employee’s monthly pay will not cover all of the tax and NIC arising. This results in a situation where the employee is left owing the company the remainder.
Section 222 ITEPA 2003 states that the employee must ‘make good’ the due amount, to the employer, within 90 days of the end of the tax year, otherwise the outstanding amount is treated as additional earnings subject to income tax and NIC.
This 90-day deadline is a strict one, which the courts have interpreted accordingly. There is no mechanism to recover the additional tax charge, even when the employee does reimburse the employer at a time outside the deadline, so care must be taken to avoid the charge arising in the first place.
Chilcott, Griffiths and Evolution Group Services v Revenue and Customs
In the above case, two employees were awarded with shares, which were RCAs. Income tax and NIC totalling approximately £800,000 was reported through PAYE. However, rather than the employees making payments to the employer to settle the liability, they made payments through their self-assessment tax returns.
The court found as the wording of the legislation was clear and unambiguous, they were unwilling to consider the purpose of the legislation. The court confirmed an additional income tax charge arises unless:
- The employee reimburses the employer the income tax and NIC; and
- The reimbursement is made within 90 days of the end of the tax year.
By making payments through their self-assessment, the employees had failed to follow the precise wording of the legislation and therefore triggered the additional tax charge. This resulted in an additional tax liability of £330,000 arising, which could easily have been avoided, if the employees had simply paid the funds into the company’s bank account.
The result of a s.222 charge means an additional rate taxpayer could pay an effective tax rate of 64% on a share acquisition.
Forbes Dawson View
While the facts of the case are unusual, it is relatively common for employees to experience difficulty paying a dry tax charge, which arises on the award of shares. In these circumstances, putting mechanisms in place to allow the employee to make payments within the 90 day deadline should be treated as a priority. Perhaps the company would be prepared to pay the employees a bonus to allow them to repay the tax, or alternatively it could make a loan (both having tax implications of their own).
Of course, it is always advantageous to structure share awards so that the shares are not RCAs and so avoid the NIC charge entirely. This can often be achieved by ensuring that shares in the parent company are issued.
Finally, the above case is worth storing up as ammunition against HMRC should they try to put forward a purposive argument that works against the tax player. It seems HMRC are happy to apply the strict letter of the law when it works against the taxpayer, but then plead for a purposive approach when it feels that the taxpayer is unjustly rewarded by a strict interpretation.
