Share schemes have been around for decades and are widely used by employers across many countries. In this article, I provide an overview of share schemes for globally mobile employees, including some of the key considerations for payroll.
Why do employers implement share schemes?
Share schemes are seen as a way of both retaining and incentivising employees. Traditionally, they have also been viewed as a means of aligning employees more closely with the long-term success of their employer and the creation of shareholder value.
From a retention perspective, employees who participate in a share scheme can normally only enjoy any gain once a period of time has elapsed and certain conditions have been met (which often includes remaining in employment during the ‘vesting period’). The vesting period is normally the period between the employee being awarded the right to shares under a scheme (the grant date) and the date on which they acquire the shares or become entitled to acquire the shares (the vesting date). Often, the vesting period will be at least three years, though it can be shorter.
Regarding incentivisation, the potential to benefit from shares is often linked to certain performance conditions. So, if an employee does not meet all of the specified conditions, they may lose their right to some or all of the shares granted before they vest.
Given the often lengthy vesting periods, share schemes are widely viewed as a counterbalance to the short-term nature of cash bonuses which are typically awarded in respect of a financial year or some other shorter period of time.
Why are share scheme gains put through payroll?
In the UK and overseas, any gain under a share scheme (i.e. when it vests or when an option is exercised) is normally treated as employment income as, as such, may be subject to tax withholding (i.e. PAYE in the UK) and social security (i.e. NIC in the UK). This is where payroll comes in.
However, not all gains need to be taxed via payroll in the UK. Only where the underlying shares are deemed to be “Readily Convertible Assets” (“RCA”). In simple terms, shares are deemed to be RCAs where it is possible for an employee to sell the shares. However, as often with shares, the reality is more complex and the full definition of an RCA can be found in HMRC's internal manual for PAYE & NICs.
Note that, whilst the gain when the shares vest (or options are exercised) is treated as employment income, if the employee goes on to sell their shares, any further gain would normally be treated as a capital gain to the employee on which they must personally account for tax. Typically, the taxable gain will generally equate to any increase in value of the shares from the date that they are acquired (e.g. the vesting date) to the date that they are sold. Therefore, where shares vest and are sold on the same day, then we would not normally expect to see a capital gain.
What makes payroll complex for globally mobile employees?
Over the years there has been a proliferation in the types of share schemes out there. They come in all shapes and sizes, including share options, conditional shares, restricted stock units, flowering shares, growth shares and restricted shares, to name but a few.
Furthermore, the name given to a scheme can be deceptive.
When I was learning about share schemes in my early career, my manager would always drum this into me by asking the question “What is the animal, Lee?!”. What she meant by this is that in order to correctly determine the payroll treatment of a share event (e.g. a share exercise or vest), you first need to under the tax and NIC treatment and this, in turn, is dependent on the particular rules of the scheme (i.e. the animal). One so-called share option scheme, for example, may have an entirely different treatment to another, depending on the particular rules of the scheme.
Beyond the complexities of understanding the particular scheme rules is then the fact that, for globally mobile employees, not all of an employee’s share gain may be subject to tax and NIC in the UK and, quite possibly, part or all of the gain may be subject to tax overseas. Often, the gain is ‘pro-rated’ between two countries under the domestic legislation of each country or under a double tax treaty.
Example
By way of a simple example to demonstrate the principles, take a globally mobile employee who relocates from the US to the UK on 1 January 2019 for three years to work with the UK subsidiary company of their US employer. The employee was granted restricted stock units on 1 January 2018 (i.e. one year before their departure) by their US employer.
The restricted stock units have a 3-year vesting period. The RSUs vest on 1 January 2021 when the employee is still resident and working in the UK. Let’s say that the employee’s total workdays between grant and vest is 720 and, of this total, 240 days were worked in the US and 480 days were worked in the UK.
In these circumstances, one-third of any gain (i.e. 240/720) when the RSU’s vest would be subject to US tax and two-thirds (i.e. 480/720) would be subject to UK tax. This pro-ration is possible under the terms of the US/UK double tax treaty.
Assuming the shares are listed on a stock exchange, they would automatically be considered RCA and so PAYE would be required.
Of course, in practice, the position and calculations are likely to be much more complex. Furthermore, in addition to the tax position, the NIC position should be considered separate since the tax treatment and the NIC treatment are not always aligned. Normally, specialist tax advice will be required.
What are the key steps for payroll?
Despite the complexity, in general, if payroll is asked to ‘process a share scheme gain’, then the following steps should help arrive at the correct approach:
- Determine whether the shares are readily convertible assets.
- Review the share scheme rules and determine the UK tax and NIC treatment of gains under the share scheme.
- Determine the portion of any gain that should be subject to PAYE in the UK by reference to the employee's workdays in the UK and the overseas country as a proportion of total workdays during the period from grant to vest.
- Process the taxable UK gain via payroll*.
- Complete Year End Share Scheme Reporting with HMRC by 6 July, where required.
*In my next article, I will be setting out how to manage the position regarding Step 4 with regard to the rules on the recovery of PAYE from employees where this is not deducted directly from the employee’s share gain.
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com
Share schemes have been around for decades and are widely used by employers across many countries. In this article, I provide an overview of share schemes for globally mobile employees, including some of the key considerations for payroll.
Why do employers implement share schemes?
Share schemes are seen as a way of both retaining and incentivising employees. Traditionally, they have also been viewed as a means of aligning employees more closely with the long-term success of their employer and the creation of shareholder value.
From a retention perspective, employees who participate in a share scheme can normally only enjoy any gain once a period of time has elapsed and certain conditions have been met (which often includes remaining in employment during the ‘vesting period’). The vesting period is normally the period between the employee being awarded the right to shares under a scheme (the grant date) and the date on which they acquire the shares or become entitled to acquire the shares (the vesting date). Often, the vesting period will be at least three years, though it can be shorter.
Regarding incentivisation, the potential to benefit from shares is often linked to certain performance conditions. So, if an employee does not meet all of the specified conditions, they may lose their right to some or all of the shares granted before they vest.
Given the often lengthy vesting periods, share schemes are widely viewed as a counterbalance to the short-term nature of cash bonuses which are typically awarded in respect of a financial year or some other shorter period of time.
Why are share scheme gains put through payroll?
In the UK and overseas, any gain under a share scheme (i.e. when it vests or when an option is exercised) is normally treated as employment income as, as such, may be subject to tax withholding (i.e. PAYE in the UK) and social security (i.e. NIC in the UK). This is where payroll comes in.
However, not all gains need to be taxed via payroll in the UK. Only where the underlying shares are deemed to be “Readily Convertible Assets” (“RCA”). In simple terms, shares are deemed to be RCAs where it is possible for an employee to sell the shares. However, as often with shares, the reality is more complex and the full definition of an RCA can be found in HMRC's internal manual for PAYE & NICs.
Note that, whilst the gain when the shares vest (or options are exercised) is treated as employment income, if the employee goes on to sell their shares, any further gain would normally be treated as a capital gain to the employee on which they must personally account for tax. Typically, the taxable gain will generally equate to any increase in value of the shares from the date that they are acquired (e.g. the vesting date) to the date that they are sold. Therefore, where shares vest and are sold on the same day, then we would not normally expect to see a capital gain.
What makes payroll complex for globally mobile employees?
Over the years there has been a proliferation in the types of share schemes out there. They come in all shapes and sizes, including share options, conditional shares, restricted stock units, flowering shares, growth shares and restricted shares, to name but a few.
Furthermore, the name given to a scheme can be deceptive.
When I was learning about share schemes in my early career, my manager would always drum this into me by asking the question “What is the animal, Lee?!”. What she meant by this is that in order to correctly determine the payroll treatment of a share event (e.g. a share exercise or vest), you first need to under the tax and NIC treatment and this, in turn, is dependent on the particular rules of the scheme (i.e. the animal). One so-called share option scheme, for example, may have an entirely different treatment to another, depending on the particular rules of the scheme.
Beyond the complexities of understanding the particular scheme rules is then the fact that, for globally mobile employees, not all of an employee’s share gain may be subject to tax and NIC in the UK and, quite possibly, part or all of the gain may be subject to tax overseas. Often, the gain is ‘pro-rated’ between two countries under the domestic legislation of each country or under a double tax treaty.
Example
By way of a simple example to demonstrate the principles, take a globally mobile employee who relocates from the US to the UK on 1 January 2019 for three years to work with the UK subsidiary company of their US employer. The employee was granted restricted stock units on 1 January 2018 (i.e. one year before their departure) by their US employer.
The restricted stock units have a 3-year vesting period. The RSUs vest on 1 January 2021 when the employee is still resident and working in the UK. Let’s say that the employee’s total workdays between grant and vest is 720 and, of this total, 240 days were worked in the US and 480 days were worked in the UK.
In these circumstances, one-third of any gain (i.e. 240/720) when the RSU’s vest would be subject to US tax and two-thirds (i.e. 480/720) would be subject to UK tax. This pro-ration is possible under the terms of the US/UK double tax treaty.
Assuming the shares are listed on a stock exchange, they would automatically be considered RCA and so PAYE would be required.
Of course, in practice, the position and calculations are likely to be much more complex. Furthermore, in addition to the tax position, the NIC position should be considered separate since the tax treatment and the NIC treatment are not always aligned. Normally, specialist tax advice will be required.
What are the key steps for payroll?
Despite the complexity, in general, if payroll is asked to ‘process a share scheme gain’, then the following steps should help arrive at the correct approach:
- Determine whether the shares are readily convertible assets.
- Review the share scheme rules and determine the UK tax and NIC treatment of gains under the share scheme.
- Determine the portion of any gain that should be subject to PAYE in the UK by reference to the employee's workdays in the UK and the overseas country as a proportion of total workdays during the period from grant to vest.
- Process the taxable UK gain via payroll*.
- Complete Year End Share Scheme Reporting with HMRC by 6 July, where required.
*In my next article, I will be setting out how to manage the position regarding Step 4 with regard to the rules on the recovery of PAYE from employees where this is not deducted directly from the employee’s share gain.
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com