Income from employment Structure of computation

1
Income from employment - Structure of computation
Theory and practice of taxation AModule code
C33TA1 Lec 6

• Employment Income Salary, bonus, commission
  XBenefits in kind XLump sum
  payments on obtaining employment XLump sum
  termination payments XShare incentives and
  options XIncome from pensions
  X XLess Allowable expenses
  (X) Less Allowable pension contributions
  qualifying (X) for relief Total
  assessment X

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Income from employment -Lump Sums on Taking Up
Employment

• An employer may make a payment to an employee of
  another firm to induce him/her to join them
• Such sums (Golden Hellos) are taxable in full
• (Shilton v Wilmhurst 1991- an inducement to join
  Southampton)
• As a payment for future services
• Unless it can be shown that the payment
  represented compensation for some right or asset
  given up on taking up the employment.
• (Jarrold v Boustead 1964 - loss of amateur
  status)
• BUT such payments may be taxable under CGT

3
Income from employment -Lump Sums - 2

• Sums paid in return for an employee agreeing to
  restrict their conduct or activities (Golden
  Handcuffs)
• E.g. Agreeing not to leave to join a competitor
  within a certain period of time
• Are subject to Income Tax and National Insurance
• Even if received in non-cash form - the value of
  the benefit is taxable

4
Income from employment - Payments on Termination
of Office 1

• These may be
• Entirely exempt
• Partly exempt
• Entirely chargeable

5
Income from employment - Payments on Termination
of Office 2

• These are exempt
• Payments on accidental death
• Payments on account of injury or disability
• Lump sum payments from approved pension schemes
• Legal costs recovered by the employee from the
  employer following legal action to recover
  compensation for loss of employment

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Income from employment - Payments on Termination
of Office 3

• These are liable in full
• Payments to which the employee is contractually
  entitled
• (Thorn EMI Electronics Ltd v Caldicott 1999)
• This includes payments
• for work done (terminal bonuses)
• for extra work done during a period of notice
• in lieu of notice (where stated in the original
  contract)
• for extending a period of notice.

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Income from employment - Payments on Termination
of Office 4

• Other payments
• Compensation for loss of office
• Statutory redundancy pay
• Are not taxable under the normal Employment
  Income rules (they are not in return for
  services)
• BUT are brought within the Employment Income net
  by statute
• Are partially exempt
• The first 30,000 is exempt any excess is
  taxable
• Payments and other benefits provided in
  connection with a termination /change in
  employment are taxable in the year in which they
  are received

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Income from employment - Payments on Termination
of Office 5

• EXAMPLE - REDUNDANCY PACKAGE
• Jones is made redundant on 31 December 2005. He
  received (not under a contractual obligation)
• 40,000 cash in two instalments
• 20,000 on 15 January 2006
• 20,000 on 15 January 2007
• Continued use of company car up to 5 April 2007
  (assume annual value of the benefit 5,000)
• What are his Employment Income assessments based
  on this information?

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Income from employment - Payments on Termination
of Office 6

• EXAMPLE -Solution
• 2005-06 Under the package Jones received
• Cash 20,000
• Use of car (5,000x3/12) 1,250
  21,250
• Wholly exempt - allocated 21,250 of the 30,000
  exemption - first to the cash then to the
  benefit.
• 2006-07
• Cash 20,000
• Car 5,000
  25,000
• Balance of exemption (30,000-21,250) (8,750)
• Taxable 16,250

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Income from employment - Payments on Termination
of Office 7

• Basis of assessment

• For the purpose of our course, the date of
  termination and payment will be identical. The
  basis of assessment will then be the date of
  receipt.

11
Income from employment -Employee Incentive
Schemes

• Give financial incentives to employees to improve
  their work performance
• SHARE INCENTIVE PLANS (SIPs)
• SHARE OPTION SCHEMES
• ENTERPRISE MANAGEMENT INCENTIVES (EMIs)

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Employee Incentive Schemes 2SHARE INCENTIVE
PLANS 1

• Companies which set up SIPs may offer their
  employees
• Free shares in the company annually- to a maximum
  of 3,000 per employee
• The opportunity to use salary of up to 1,500
  annually (free of Income Tax and NI) to buy
  partnership shares
• Up to TWO matching shares for each partnership
  share bought by the employee
• NB Up to 7,500 worth of shares may be acquired
  annually for 900 (for a 40 taxpayer)

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Employee Incentive Schemes 3SHARE INCENTIVE
PLANS 2

• Companies may offer any combination of
• Free shares Partnership sharesPartnership and
  matching shares
• The plan may link the provision of free shares to
  employee performance targets
• Generally, all employees must be eligible to
  participate (subject to possible service
  qualifications)
• Employees holdinggt 25 of the companys ordinary
  shares cannot participate
• Plan may allow/compel annual dividends of up to
  1,500 arising on an employees shares to be
  re-invested tax free in dividend shares for the
  employee

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Employee Incentive Schemes 4SHARE INCENTIVE
PLANS 3

• All of an employees shares leave the plan on
  their ceasing employment with the company
• There are detailed rules governing the partial
  removal of each type of share from the plan.
• If free, partnership or matching shares leave the
  plan within 3 years a charge to IT and NI arises,
  based on the market value of the shares at date
  of leaving.
• If shares leave between 3 and 5 years the charge
  is based on lower of MV at dates of leaving and
  acquisition
• NO charge arises if the shares leave the plan
  after 5 years
• Employees who retain their shares in the plan
  until they sell them incur NO CGT liability
• Employees who take the shares out of the plan and
  later sell them pay CGT on the increase in value
  since leaving the plan.

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Employee Incentive Schemes 5Share option schemes
1

• Definitions
• An option is a right granted to an employee or
  director to acquire shares in the company at a
  specified time at a discount to the market value
  of the shares.
• Share option schemes are either approved or
  unapproved. The status of the scheme has a direct
  tax effect on the employee or director.

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Employee Incentive Schemes 6 Share option
schemes 2

• GENERALLY
• If a director or employee is granted an option to
  acquire shares - when the option is exercised
• There is a Employment Income charge on
• The market value of the shares
• minus the sum of
• What was paid for the option - plus
• What was paid for the shares
• If the option can be exercised more than 10 years
  after it is granted, there is also a charge at
  the time of the grant
• The liability to income tax can be avoided if the
  share option scheme is approved

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Employee Incentive Schemes 7Share option schemes
3

• ExampleMrs Parker is granted an option on 1
  April 2003, exercisable within 5 years, to buy
  1,000 shares at 5 each. The option costs 50p per
  share. She exercises the option in 2006-07 when
  the shares are worth 7.50. The option is not
  granted under an approved scheme.Determine the
  Employment Income liability arising on the
  exercise of the option in 2006-07.

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Employee Incentive Schemes 8 Share option
schemes 4

• SolutionMrs. Parker Empl. Inc 2006-07
• Market value of shares 1,000 _at_ 7.50
  7,500
• Less Cost of option 1,000 _at_ 0.50 500
• Cost of shares 1,000 _at_ 5
  5,000
  5,500
• Share option assessable benefit
  2,000

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Employee Incentive Schemes 9 Share option
schemes 5

• There are two approved share option schemes
• 1 Savings related share option schemeFunds are
  accumulated through a SAYE scheme to exercise the
  option (i.e. buy the shares). Conditions
• Savings min. 5 per month, max. 250
• Scheme must be open to all employees
• A qualifying period not exceeding 5 years may be
  imposed
• Option price must not be less than 80 of the
  value of the shares when the option was granted
• Date at which the option can be exercised must be
  3, 5 or 7 years from date the option is granted
• Contributions to SAYE scheme must be at least 3
  years
• Shares must be held for at least 3 years

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Employee Incentive Schemes 10 Share option
schemes 6

• 2 Share option scheme not linked to savings
• can be selective with regard to employees. Often
  linked to performance targets
• Conditions
• employees must be full-time directors (25 hours
  per week) or employees working at least 20 hours
• holders of 10 or more of ordinary shares in a
  close company are excluded
• the option must not be granted at a significant
  discount
• the option must be exercised between 3 and 10
  years of being granted
• employee may hold options for shares with a
  maximum value (at the time of the grant) of
  30,000

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Employee Incentive Schemes 11ENTERPRISE
MANAGEMENT INCENTIVES (EMIS)

• UK companies with assets not more than 30
  million may reward employees with tax free share
  options
• Any employee working in the company at least 25
  hours per week (or,if less, at least 75 of their
  working time)
• Company may select any employee and may award
  different amounts to each employee
• Employees owning gt 30 of companys OSC are
  excluded

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Employee Incentive Schemes 12ENTERPRISE
MANAGEMENT INCENTIVES (EMIS) 2

• Upper limit of 100,000 on the value of shares
  for which an employee may hold unexercised
  options granted
• At any time, total value of the shares for which
  options have been granted cannot exceed
  3,000,000
• NO charge to IT or NICs arises when an option is
  granted
• When the option is exercised, no charge arises if
  the shares are acquired at not less than their MV
  at date of grant

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Employee Incentive Schemes 13ENTERPRISE
MANAGEMENT INCENTIVES (EMIS) 3

• Otherwise - a charge is made based on the lower
  of
• (a) The excess of the shares MV at date of
  granting over acquisition cost
• (b) The excess of the shares MV at date of
  exercise over acquisition cost
• For CGT purposes the sale of shares acquired
  under an EMI scheme is treated as disposal of a
  asset whose holding period for taper relief
  begins on the date that the option was granted.