The impact of changes to residence and domicile rules on the taxation of employment-related securities and options

Schedule 7 of the Finance Act 2008 introduced new rules regarding the remittance basis for those individuals who are resident in the UK but are either not ordinarily resident or not domiciled here. This note provides some details of the ways in which the taxation of employment-related securities has altered as a result of Schedule 7 of the Finance Act 2008. Guidance will appear in the Employment-Related Securities Manual before the end of August, including examples of how the new rules work in practice. The purpose of this note is to draw attention to the changes, which apply to employment-related securities and securities options acquired on or after 6 April 2008.

Particular attention is drawn to the advice on the extended time limit for elections under section 431 ITEPA 2003 for those employees who are newly brought into the charging provisions of Chapter 2 of Part 7 of ITEPA.

General earnings

The acquisition of securities is normally charged as money’s worth within general earnings of the employee. Where this is the case, the effect of the residence, ordinary residence and domicile status of the employee on the charge is precisely the same as with cash earnings.
Up until 5 April 2008 the effect of residence and domicile status on the taxation of general earnings was governed by:

ITEPA03/S15 (earnings for year when employee resident, ordinarily resident and domiciled in UK)
ITEPA03/S21 (earnings for year when employee resident and ordinarily resident but not domiciled in UK (non-domiciled), except chargeable overseas earnings)
ITEPA03/S22 (chargeable overseas earnings for year when employee resident and ordinarily resident, but not domiciled, in UK)
ITEPA03/S25 (UK-based earnings for year when employee resident, but not ordinarily resident, in UK (R/NOR))
ITEPA03/S26 (Foreign earnings for year when employee resident, but not ordinarily resident, in UK)
ITEPA03/S27 (UK-based earnings for year when employee not resident in UK)

Finance Act 2008 made changes to these provisions such that from 6 April 2008:

sections 21 and 25 are omitted
section 15 now deals with earnings for a year when the employee is UK resident
section 22 deals with chargeable overseas earnings for a year when the remittance basis applies and the employee is ordinarily UK resident
section 26 deals with foreign earnings for a year when the remittance basis applies and the employee is not ordinarily UK resident
Section 27 continues to apply as before

The broad principle of taxation of the general earnings of UK resident employees who are either not domiciled in the UK or are not ordinarily UK resident (NOR) continues to be that general earnings in respect of foreign duties for foreign employers (in the case of 'non-domiciles') and foreign duties in general (in the case of 'R/NORs') are charged to income tax only to the extent that they are remitted to the UK.

Specific employment income

The charges in Part 7 of ITEPA relating to employment-related securities and options are not directly governed by sections 15 to 27 of ITEPA. However, whether a particular Chapter of Part 7 applies depends on whether those sections apply to general earnings in the relevant year.

The rules are set out in ITEPA03/S421E for securities and in ITEPA03/S474 for securities options.

Up until 5 April 2008

Chapter 2 (restricted securities)
Chapter 3 (convertible securities)
Chapter 4 (post-acquisition benefits)
Chapter 5 (securities options)

of Part 7 ITEPA only applied if the earnings from an individual’s employment were general earnings to which sections 15 or 21 applied: that is; the individual was resident and ordinarily resident (R/OR) at the time of acquisition of the security or option.
However,

Chapter 3A (securities with artificially depressed market value);
Chapter 3B (securities with artificially enhanced market value);
Chapter 3C (securities acquired for less than market value); and
Chapter 3D (securities disposed of for more than market value)

of Part 7 applied not only to employees who were R/OR at the time of acquisition, but to employees whose earnings from the employment were general earnings to which any of the charging provisions of Chapter 4 or 5 of Part 2 apply at acquisition. (There is no specific residence rule affecting the relief under Chapter 4A, as it disapplies the charges under Chapter 2, 3B and 4, which have their own residence rules.)

The wider application of Chapters 3A to 3D had some odd and erratic effects. The most commonly encountered of these was that employees who were resident but not ordinarily resident in the UK at the grant of a securities option could be charged to tax by virtue of Chapter 3C on a notional loan, based on the value of the securities at the time the option was exercised and on the 'discharge' of that loan at the time the securities were sold. (See the guidance at ERSM70400 et seq.)

Impact of Finance Act 2008 residence and domicile rules on employment-related securities & options

With the removal of ITEPA03/S21 and the consequential changes to Sections 421E(1) and 474(1) of the same Act by Finance Act 2008 from 6 April, 2008 Chapters 2, 3, 4 and 5 of Part 7 ITEPA now apply if the individual concerned is UK resident at the time of acquisition regardless of whether or not he or she is ordinarily resident (or UK domiciled).

The extension of the application of the aforementioned Chapters of Part 7 to employees who, when they acquire securities or options, are not ordinarily resident, demanded consideration of a means of recognising that some of the employment income that would be charged by Part 7 might relate to foreign duties. It was also felt appropriate that existing, informal recognition in this guidance of the remittance basis for Part 7 income from foreign duties for foreign employers by 'non-domiciles' should be recognised in statute. As a result, from 6 April 2008, new Chapter 5A of Part 2 of ITEPA 2003 applies the remittance basis to such employment income.

Commencement of the new rules

The new rules of Chapter 5A, Part 2 of ITEPA 2003 apply to employment-related securities options and employment-related securities acquired on or after 6 April 2008, except where employment-related securities are acquired pursuant to a securities option which was acquired before 6 April 2008.

Where options that have been acquired before 6 April 2008 are replaced by new options in accordance with ITEPA03/S483 (see ERSM110800) on or after 6 April 2008, then the new option will continue in the old regime and will not be subject to Chapter 5A of Part 2 of ITEPA03.

Example

Tom is R/NOR when, on 25 February 2008, he is granted an option to acquire securities in his employer company. He exercises his option on 30 September 2008 and thereby acquires employment-related securities for less than their market value. As the securities were acquired pursuant to a securities option which was itself acquired before 6 April 2008, the old rules of Chapter 3C will apply and the guidance at ERSM70420 et seq should be followed.

Period from 6 April 2008 to Royal Assent

The new rules on remittance basis for employment-related securities are retrospective back to 6 April 2008 from the date of Royal Assent: that means that between 6 April and Royal Assent the law as it currently stands applies in its full force. Following Royal Assent, the retrospective nature of the legislation means that the law has to be regarded as rewritten.

So, for example, where on 30 April 2008 R/NOR employees acquired securities options or securities that were forfeitable within five years, since Chapters 5 and 2 of Part 7 of ITEPA did not apply, the exemptions from a money’s worth, general earnings charge that are provided in those Chapters similarly did not apply. It might therefore be the case that an employer faced PAYE (Pay As You Earn) and National Insurance contributions obligations on the award of an option or securities which, following Royal Assent, were removed, as the awards were exempt from an income tax charge by virtue of the rules of Part 7. See below for guidance on the operation of PAYE on the period between 6 April 2008 and Royal Assent and the remainder of the 2008-09 tax year.

Principles of the new rules

New rules for general earnings

The new rules relating to residence and domicile introduced by Finance Act 2008 bring all UK-resident individuals within the scope of ITEPA03/S15 with effect from 6 April 2008.

However, for those individuals who are not ordinarily resident in the UK (NOR) in a tax year, or not domiciled in the UK (non-dom) for a tax year, the remittance basis may apply for that tax year, either by a claim under ITA07/S809B, or by sections 809D or 809E.

Under the remittance basis, the chargeable overseas earnings of an individual who is non-dom for that year are charged in accordance with ITEPA03/S22 and the foreign earnings of an NOR individual are charged in accordance with ITEPA03/S26. Broadly speaking, sections 22 and 26 provide that those earnings are only subject to UK income tax if they are remitted to the UK. ITA07/S809L provides the rules on the meaning of ‘remitted’.

Application of Part 7 ITEPA to all UK residents

Prior to 6 April 2008, individuals who were resident but not ordinarily resident in the UK were subject to the provisions of Chapters 3A to 3D of Part 7 ITEPA, by virtue of ITEPA03/S421E(2). However, they were not subject to the provisions of Chapter 2, 3 or 4 of Part 7, because of ITEPA03/S421E(1).

For example, when they acquired forfeitable shares, the rules in Chapter 2 of Part 7 did not apply to them so they were potentially subject to a general earnings charge at the time of acquisition. However, when the forfeiture restriction lifted, they were not subject to Chapter 2 so there was no specific employment income charge.

Because of the amendments made to ITEPA03/S421E by Finance Act 2008, for employment-related securities acquired on or after 6 April 2008 (except those acquired pursuant to a securities option acquired before 6 April 2008), all UK-resident individuals are within the scope of Chapters 2 to 4 of Part 7 ITEPA 2003.

Similarly for options, prior to 6 April 2008, individuals who were NOR were not subject to the provisions of Chapter 5 because of ITEPA03/S474(1).

Therefore when they acquired an option, the rules in Chapter 5 of Part 7 did not apply so they were potentially subject to a general earnings charge at the time of acquisition on the money’s worth of the option (see ERSM110110). When the option was exercised, again, the rules in Chapter 5 did not apply. However, the rules in Chapter 3C were often triggered so that the option gain was treated as a notional loan.

Because of the amendments made to section 474 by FA 2008, for employment-related securities options acquired on or after 6 April 2008, all UK resident individuals are within the scope of Chapter 5 of Part 7 ITEPA 2003.

Extended time limit for section 431 elections

Where restricted securities are acquired in the period 6 April to 31 July 2008 inclusive, and Chapter 2 of Part 7 of ITEPA applies to them by virtue only of the provisions of Schedule 7, then section 431 ITEPA elections may be made no later than 14 August 2008. The election means that employers and employees have the choice of opting out of Chapter 2 and the extension of the time limit ensures that people newly brought into the rules in Part 7 ITEPA have the opportunity to make section 431 elections after the new rules in Schedule 7 came into force when Finance Act 2008 received Royal Assent – on 21 July 2008.

The remittance basis for ERS

Paragraph 22 of Schedule 7 of Finance Act 2008 introduces a new Chapter 5A of Part 2 ITEPA 2003 to deal with the effect of the remittance basis on the taxation of employment-related securities.

If an amount counts as employment income under Chapters 2, 3 or 3C to 5 (excluding section 446UA) of Part 7 ITEPA, and the remittance basis applies during any part of the relevant period, then ITEPA03/S41A will apply.

Subsection (4) provides that, instead of the whole amount which counts as employment income being taxable in the UK on the arising basis, only that part which relates to the UK is so taxable.

It achieves this by use of a formula:

taxable specific income = SI – FSI
where
SI is the amount of the securities income, and
FSI is the amount of the securities income that is ‘foreign’

The extent to which the securities income is ‘foreign’ is determined under ITEPA03/S41C.

Relevant period

ITEPA03/S41A(1) sets out the conditions which must be met for the remittance basis to apply to employment income chargeable under Chapters 2, 3, 3C (except section 446UA), 3D, 4 & 5 of Part 7 ITEPA.

The first condition is that there must be an amount that counts as an individual’s employment income for a tax year, in respect of an employment, by virtue of one of the above Chapters (subsection (1)(a)).

The second is that some part of the relevant period must be within a tax year for which section 809B, 809D or 809E ITA 2007 (remittance basis) applies to the individual (subsection (1)(b)).

ITEPA03/S41B then goes on to explain what is meant by the concept of the 'relevant period'. The general intention is that the relevant period should represent the period in which the income is earned, or to which it most closely relates.

Relevant period: restricted or convertible securities

ITEPA03/S41B(2) says that where there is an amount which counts as employment income by virtue of Chapter 2 (restricted securities) or Chapter 3 (convertible securities), the relevant period -

begins with the day the securities are acquired, and
ends with the day of the chargeable event

See ERSM30390 for guidance on what constitutes a chargeable event for the purposes of Chapter 2; and ERSM40060 on what constitutes a chargeable event for the purposes of Chapter 3.

See below for examples of how the relevant period rules work for Chapter 2 and Chapter 3 respectively.

Relevant period: Chapter 2 examples

Example 1: single chargeable event

On 1 July 2008 Alex is awarded securities by his employer which will be forfeited if he leaves his employment on or before 30 June 2010. Alex is R/NOR throughout this period and splits his working time between the UK and the USA. He remains in the employment and the forfeiture condition lifts on 30 June 2010, giving rise to a Chapter 2 chargeable event. He claims the remittance basis under ITA07/S809B for each of the three tax years – 2008-09, 2009-10 and 2010-11 – concerned.

The relevant period runs from 1 July 2008 to 30 June 2010.

Example 2: multiple chargeable events

The facts are as in Example 1, except that in addition to the forfeiture condition, Alex is not allowed to sell his shares for five years from the date of acquisition. This condition lifts on 30 June 2013, giving rise to a second chargeable event under Chapter 2. For 2011-12 and later years, Alex is R/OR (and UK-domiciled).

First chargeable event: as before, the relevant period runs from 1 July 2008 to 30 June 2010.

Second chargeable event: the relevant period runs from 1 July 2008 to 30 June 2013.

The fact that Alex is not entitled to the remittance basis for 2011-12 and later years does not affect the relevant period. The remittance basis applies for at least part of the relevant period, so the rules of Chapter 5A will apply.

Example 3: elections to ignore the effect of restrictions on market value at acquisition

The facts are as in Example 1, except that Alex and his employer make an election under ITEPA03/S431(1) for ss425 to 430 not to apply to his acquisition and for the market value of the forfeitable shares to be calculated as if they were not forfeitable.

As a result, Alex is treated as receiving earnings in the form of the money’s worth of the shares, in accordance with ITEPA03/S62. As the acquisition gives rise to general earnings rather than specific employment income by virtue of Chapter 2 of Part 7 of ITEPA03, it follows that the rules of Chapter 5A of Part 2 of ITEPA03: for remittance basis on employment income arising from the provisions of Part 7, do not apply. Instead, the residence rules for general earnings in Chapters 4 and 5 of Part 2 of ITEPA03 would apply and the year(s) that the earnings are for will be decided in accordance with those rules.

Relevant period: securities acquired for less than market value

Section 41B(3) says how the relevant period is determined where there is an amount which counts as employment income by virtue of 446U on the discharge of a notional loan within Chapter 3C (see ERSM70140). The relevant period will differ depending on whether or not the securities are acquired pursuant to a securities option.

Relevant period: securities acquired for less than market value pursuant to securities option

Where the securities in question were acquired by virtue of the exercise of a securities option, the relevant period:

begins with the day of the acquisition of the option, and
ends with the day the option vests

(Note: an option 'vests' at the time it is first capable of being exercised (ITEPA03/S41B(7)).

Example

Ian is working in France but knows he will shortly move to the UK with the same employer when, on 1 March 2009, he is granted an option to acquire securities. He is not resident in the UK for tax purposes for 2008-09. In the next tax year he moves to the UK as planned. He is R/NOR for 2009-10 and remains so until exercise of the option two years later. He claims the remittance basis under section 809B ITA 2007 throughout his stay in the UK.

Ian is not within Chapter 5 as he was not UK-resident in the year he was granted the option. He is within Chapter 3C, as he is UK-resident in the year he acquires shares on exercise of his option.

The relevant period runs from the date the option is granted to the date on which the option is first capable of being exercised (and not, if later, the date on which exercise occurs).

If Ian had been awarded his option without prior knowledge of his move to the UK, then a charge under Chapter 3C would not be pursued. See ERSM70410.

Relevant period: securities acquired for less than market value other than pursuant to securities option

In a Chapter 3C case not involving a securities option, the relevant period is the tax year in which the notional loan (within the meaning of Chapter 3C) is treated as made or, if the notional loan is discharged in the same year, so as to give rise to employment income by virtue of ITEPA03/S446U(2) (see ERSM70140), then the relevant period starts with the beginning of the year and ends on the day of the discharge.

In general, this means that the relevant period will be the tax year in which the securities are acquired or, if shorter, the period from 6 April preceding (or simultaneous with) the acquisition of the securities to the date of their disposal or of release of the outstanding liability to pay for them.

Example

Stephen is awarded shares worth £1 each, but is only required to pay 10p per share initially. He is R/NOR in the year of award (year 1) and claims the remittance basis under ITA07/S809B in that year. At the end of the year he leaves the UK and has no further connection with the UK from that point. Two years later (year 3) he sells the shares with the 90p call on each share still outstanding.

The relevant period is year 1, ie the tax year in which Stephen acquired the partly-paid shares. This is so even though the charge under section 446U on the deemed discharge of the notional loan arises in year 3.

The reason for this approach is that the amount of the future section 446U charge is fixed at the time of acquisition, even though the charge itself may not arise until much later. The section 446U income is therefore most closely related to the year of the acquisition.

Relevant period: securities disposed of for more than market value

ITEPA03/S41B(4)(a) says that where there is an amount which counts as employment income by virtue of Chapter 3D (securities disposed of for more than market value) the relevant period is the tax year in which the disposal occurs.

Example

Andrew is awarded shares by his employer on the basis that he can sell the shares back at any time for the same price he paid. The shares fall in value, and Andrew takes advantage of this 'stop loss' arrangement, selling the shares back for more than they are now worth.

The relevant period is the tax year in which the disposal occurs. Andrew is R/NOR and claims remittance basis under ITA07/S809B for that year.

Relevant period: post-acquisition benefits from securities

ITEPA03/S41A(4)(b) says that where there is an amount which counts as employment income by virtue of Chapter 4 (post-acquisition benefits from securities) the relevant period is the tax year in which the benefit is received.

Relevant period: securities options

ITEPA03/S41B(5) says that where there is an amount which counts as employment income by virtue of Chapter 5 (employment-related securities options) the relevant period –

begins with the day of the acquisition of the option, and
ends with the day of the chargeable event or, if earlier, the day the option vests.

Where options vest in stages; eg a fifth on the each of the first to fifth anniversaries, or have several vesting targets (so vest if employment continues up to a particular date and a performance condition is met), then vesting will be regarded as occurring at separate times in respect of the relevant parts of the option.

Example

Zoë is awarded a share option by her employer. She is R/NOR and claims the remittance basis under ITA07/S809B in the year the option is granted and in subsequent years. Before the option vests, Zoë agrees with her employer to give up the option in return for a cash payment. The cash payment is a benefit in connection with her option, and the payment of the benefit is therefore a chargeable event within section 477(3)(c) ITEPA.

The relevant period runs from the date of grant of the option to the date the benefit arises.

Had Zoë held onto the option until it vested, the relevant period would have run from the date of grant of the option to the date of vesting.

'Vesting'

For the purposes of ITEPA03/S41B, an option vests when it becomes capable of being exercised.

Ascertaining FSI

The concept of 'foreign securities income' is introduced by ITEPA03/S41A(5). Section 41A(5)(b) says that foreign securities income ('FSI') is the amount of securities income that is foreign. The detail on what this means is given at ITEPA03/S41C. If an employee has FSI it will only be taxed if it is remitted to the UK (ITEPA03/S41A(6)).

Daily accrual

The securities income is to be treated as accruing equally on each day of the relevant period (ITEPA03/S41C(2)).

This should not be read as a requirement to compute the apportionment of securities income between what is foreign and what is not on the basis of the circumstances of every day during the relevant period. Rather, because the apportionment rules of section 41C treat each tax year within the relevant period separately, the concept of daily accrual means that securities income is regarded as relating in equal proportions to each year or part of a year within the relevant period.

The statute at ITEPA03/S41C and S41D requires that for both categories of employees who are eligible for the remittance basis – those who are not ordinarily resident in the UK (NOR) and those who are ordinarily resident but not domiciled in the UK – the securities income will be apportioned between what is foreign and what is not.

For non-domiciled employees the apportionment will be made in accordance with ITEPA03/S41C(3) and (4) and S41D. For NOR employees the apportionment is governed by ITEPA03/41C(5) and (6).

For both categories of employees, the way that the apportionment is made is not set down in statute in any more detail than is contained in sections 41C and 41D. HMRC would expect that a split based on overseas and UK workdays will be the most commonly used method of arriving at a just and reasonable apportionment, but other methods will be acceptable if they achieve a just and reasonable result.

Just and reasonable override

ITEPA03/S41E provides that where the amount of foreign securities income that is calculated in accordance with ITEPA03/S41C is not, having regard to all the circumstances just and reasonable, then a just and reasonable figure may be substituted.

The aim of the apportionment rules in Chapter 5A is, for employment income charges arising under Part 7 of ITEPA for UK-resident employees, to broadly replicate the effect of the charging provisions that apply to the general earnings of UK-resident employees.

So, where the foreign earnings of an employee who is resident in the UK but not ordinarily resident there are, by virtue of ITEPA03/S26, subject to UK tax only to the extent that they are remitted, Chapter 5A attempts to identify the portion of an employment-related securities gain that relates to duties performed outside the United Kingdom.

Similarly, where the chargeable overseas earnings of an employee who is resident and ordinarily resident but not domiciled in the UK are only subject to UK tax if and when remitted by virtue of ITEPA03/S22, again, Chapter 5A attempts to apportion employment income from employment-related securities between overseas duties for a foreign employer and duties of an associated employment in the same way that ITEPA03/S24 does for general earnings.

The detailed apportionment rules try to achieve this by envisaging the gain as accruing equally over the whole of a relevant period. The relevant period is the period over which the gain could be regarded as having been earned.

There may be circumstances where the relevant period laid down in ITEPA03/S41B does not match the reality of the period over which the gain can fairly be said to have been earned. There may be other circumstances when the gain could not fairly be said to have been earned in equal amounts over each day of the relevant period. In such circumstances, the just and reasonable override acts to replace the amount calculated by s41C with a just and reasonable amount.

The legislation does not set out how this is to be achieved. Instead, the intention is to have regard to the general aim of the apportionment rules as mentioned above; to broadly replicate the effect of the charging provisions that apply to the general earnings of UK-resident employees.

PAYE and National Insurance contributions

Securities and securities options acquired between 6 April 2008 and Royal Assent

Up until Royal Assent the law as it stood previously was in full force. After Royal Assent, the wider application of the Part 7 rules has retrospective effect from 6 April 2008.

No PAYE or National Insurance contribution responsibilities (other than reporting requirements on Form 42) apply to chargeable events that occur in the period between 6 April 2008 and Royal Assent if the law as it stood prior to Royal Assent does not impose them. After Royal Assent, the employer is not required to revisit events prior to that date, even though the new law has retrospective effect from 6 April 2008.

In some circumstances employers may have operated PAYE and National Insurance contributions in respect of awards of securities or securities options that occurred between 6 April 2008 and Royal Assent that, following Royal Assent, should not have given rise to such charges. So, for example, where R/NOR employees acquired securities options or securities that were forfeitable within five years, since Chapters 5 and 2 of Part 7 of ITEPA did not apply, the exemptions in those Chapters from a money’s worth general earnings charge similarly did not apply. It might therefore be the case that an employer faced PAYE and National Insurance contributions obligations on the award of an option or securities which, following Royal Assent, were removed, as the awards were exempt from an income tax charge by virtue of the rules of Part 7.

So, an employer might deduct PAYE tax on the award of, say forfeitable securities, in accordance with the old rules up to Royal Assent and, following the retrospective application of the new rules back to 6 April 2008, find that the income tax and National Insurance contibutions liability attached to that award has now been removed. In these circumstances the employer should make careful amendment of the pay record to remove the ‘non taxable’ payment. In the next tax period(s) the tax will then be repaid to the individual by an increase in their Net Pay per the tax tables and their tax code. A note should be made for auditing purposes.

If the employee has left the employment then the employer should not seek to re-issue a P45, but may want to make the ex-employee aware that tax was deducted on a non taxable figure. The employer should not repay the tax to the ex-employee. The ex-employee should then make a claim at a later point upon presentation of P45 to HM Revenue & Customs (HMRC).

PAYE: remittance basis

ITEPA03/S696 requires that where PAYE income is provided in the form of a readily convertible asset, the amount on which the employer must operate PAYE is the employer’s best estimate that can reasonably be made of what is likely to be PAYE income.

ITEPA03/S698 stipulates how PAYE should be applied to charges in respect of employment-related securities. In general, where an amount is treated as employment income by virtue of one of the charging provisions of Part 7 of ITEPA 2003, then the reference in ITEPA03/S696 to the amount likely to be PAYE income is a reference to what is likely to count as employment income by virtue of the Part 7 charge. ITEPA03/S700 applies PAYE to gains from securities options in a broadly similar way to the way section 698 does for charges on employment-related securities

ITEPA03/S700A provides that, where section 698 or 700 applies and part or all of the amount that counts as employment income is (or is likely to be) foreign securities income then the amount of the payment that is treated as being made for PAYE purposes under section 696 is the full amount of the employment income arising under Part 7, less the amount that is likely to be foreign securities income by virtue of ITEPA03/S41C to 41E.

This means that, if the employer has sufficient information to calculate the amount of employment income which is foreign securities income (that is; the amount that is taxable on the remittance basis), then it is the net amount of employment income after deduction of the foreign securities income on which PAYE should be operated. Where the employer does not have sufficient information to calculate, using the best estimate that can reasonably be made, the amount of foreign securities income, then PAYE should be operated on the full amount of the employment income, subject to any apportionment the employer has sufficient information to make in respect of treaty exemption.

An example where an employer could make a reasonable estimate of an employee’s foreign securities income would be where the employer knows that the employee is resident and not ordinarily resident for the year and has evidence, such as an assurance from the employee, that a claim to the remittance basis will be made. If the employee’s overseas duties are fairly regular from year to year, and/or the expected balance of his or her UK and overseas duties for the current year is known, then the employer could reasonably estimate the FSI on the basis of its expectation for the current year.

National Insurance contributions

The international rules for National Insurance are very different from the international rules for income tax. National Insurance contributions rules are driven by treaty and wider social policy considerations which do not impinge on income tax. Therefore, the new rules providing for the apportionment of specific employment income under Part 7 of ITEPA 2003 for income tax and PAYE purposes do not apply for the purposes of National Insurance contributions. Instead, the National Insurance contributions rules are subject to their own provisions relating to internationally mobile employees within the UK legislation and/or international social security agreements.

For guidance on how the National Insurance contributions rules apply to employment-related securities in general, see ERSM170700.

National Insurance contributions liability on earnings from employment-related securities is based on the inclusion as earnings of the straightforward acquisition of securities by an employee from his employer (provided the securities are readily convertible assets) and, in addition, anything which counts as employment income under the charging provisions of Part 7 of ITEPA 2003. For employees who are resident but not ordinarily resident some gains on employment-related securities which previously would have counted as employment income only by virtue of Chapter 3C of Part 7 or which may not have counted as employment income at all, will, under the new rules, count as employment income under, for example, Chapters 2 or 5 of Part 7.

Remittance

The main material on what constitutes a remittance will be contained in the general guidance on Residence and Domicile.

Examples of ‘brought to, or received or used in, the United Kingdom’

1. Where foreign employment-related shares are sold by the employee and the cash paid into the employee’s UK bank account, that cash derives from the shares and has been ‘brought to the United Kingdom by and for the benefit of the employee’ – a relevant person (as defined by ITA07/S809M).

2. Where the employee acquires shares in a UK company, the shares are UK assets and therefore they are ‘used in the United Kingdom by and for the benefit of the employee’. As a consequence, any foreign securities income relating to those shares will be regarded as remitted to the UK when it arises.

Interaction of UK law and treaties: time apportionment

Time apportionment: securities options

If the UK is not the country of residence when a chargeable event happens, then the employee may be resident in a territory with which we have a double taxation treaty. If so, they will be able to make a claim that the UK restricts its liability to the amount derived from employment in the UK. This is commonly referred to as 'time apportionment'.

The most common situation where this arises is with share options. The Organisation for Economic Co-operation and Development (OECD) has published a paper setting out in detail the international consensus on how these should be taxed where work has been carried out in more than one territory. The UK's approach follows this and is set out, with examples, in Tax Bulletin 76. Equivalent guidance on National Insurance contributions can be found in Tax Bulletin Special Edition 8. For periods before April 2005 see Tax Bulletin 55 and DT1925+.

In the UK, share option gains are time apportioned on the basis that the right to exercise an option is earned by service from the date of grant forwards to the date the option vests, by reference to the number of workdays in each country during that period. This treatment applies to options exercised from 6 April 2005 onwards (unless the Double Taxation Agreement in question specifies otherwise - eg UK/US Treaty) and is in accordance with OECD recommendations.

For options exercised before 6 April 2005, the gain is time apportioned over the period from grant to exercise.

In view of the fact that there is an OECD consensus on the treatment of share options, HMRC is prepared to apportion gains for the purposes of the domestic charge under Part 7, where there are overseas workdays in territories having double taxation treaties with the UK, without a claim under the treaty. In cases not involving share options, it will be necessary for a claim to be made under the treaty before any apportionment can be made.

Time apportionment: Restricted and forfeitable securities

Whilst the principles outlined above will apply where shares are acquired other than via an option, the underlying facts may be different and sometimes a reduction in UK liability may not be available under a double taxation treaty.

Up until 6 April 2008, HMRC maintained that while, in general, the right to exercise an option was earned by future service from the date of the grant forwards, restricted securities (including forfeitable securities) should usually be regarded as a reward for service up to their award, but with a blocking period where the securities could be lost or before of which the recipient was unable to obtain the full benefit in cash terms. HMRC’s position was that for treaty relief, the reward from restricted securities was normally earned up to the date of the award and that the primary taxing rights belonged solely to the territory where the work was carried on up to the date of grant, not after it.

Revised practice

Following the changes of Finance Act 2008 to the taxation regime for R/NOR and R/OR but non-domiciled employees in receipt of employment-related securities, there is statutory recognition that, in general, the period in which a restricted or forfeitable security will be earned is the period between the award of the security and the lifting of the restriction or forfeiture condition. From 6 April 2008 HMRC will apply this approach to new and existing open cases for the purposes of treaty time apportionment, whether or not the rules of Chapter 5A of Part 2 of ITEPA 2003 apply and regardless of whether the securities were awarded before 6 April 2008.

This is the general approach. As with the new rules of Chapter 5A, where the facts of a case point to the conclusion that the reward relates to employment carried on during a different period than that between award and lifting of restrictions, say, for example a period from some time prior to the award to very shortly after it, then the earnings period would be regarded as that which accorded most closely with the facts.

Interaction of UK law and treaties: new remittance basis

The new rules of Chapter 5A of Part 2 of ITEPA 2003 apply to UK-resident employees on the remittance basis. Their broad effect is to restrict the amount of income from employment-related securities on which UK income tax is charged on the arising basis to that part of the income that is related to

duties in the UK (for those not ordinarily resident in the UK), or
all duties excluding those for foreign employers that are carried out entirely outside the UK (for those ordinarily resident in the UK but not domiciled here).

Frequently, employees who are eligible to make a claim under a double taxation treaty will also be those to whom Chapter 5A of Part 2 of ITEPA 2003 applies.

It may be the case that the effect of Chapter 5A will remove the need to make a claim under a treaty, either for time apportionment, or for foreign tax credit relief. Alternatively, a time apportionment claim may make the application of the Chapter 5A rules academic. Sometimes, however, the interaction of Chapter 5A and tax treaties will be more complex.

Where UK is territory of residence when chargeable event occurs

As has been mentioned, where securities or securities options are acquired after 5 April 2008, Chapter 5A of Part 2 of ITEPA taxes 'foreign securities income' only to the extent that it is remitted to the UK. In many cases, the new rules of Chapter 5A will mean that the individual will not suffer tax on the same income in the UK and a treaty partner State.

However, mismatches may occur, especially where the treaty with another State apportions the gain on an alternative basis to the domestic approach. One example of this is the UK/US Double Taxation Treaty. The US taxes the US workday proportion of a share option gain based on the workdays between grant and exercise, while Chapter 5A (which reflects OECD guidelines in this area) taxes the proportion of the gain based on UK duties between grant (referred to in the legislation as the 'acquisition' of the option) and vesting.

Where income is doubly taxed as a result, Foreign Tax Credit Relief is available in respect of foreign tax suffered on any part of the gain that has been taxed in the UK. If all or part of an amount of employment income arising from employment-related securities or employment-related securities options is foreign securities income, then, if that part is not remitted, it will not be subject to UK tax as employment income. In these circumstances, foreign tax paid on an amount of foreign securities income that has not been remitted to (and therefore not been taxed in) the UK will not be available for credit against the UK tax charged on the 'UK portion' of the income.

Where UK is not territory of residence when chargeable event occurs

As has been mentioned, if the UK is not the country of residence when a chargeable event happens, then the employee may be resident in a territory with which we have a double taxation treaty. If so, he will be able to make a claim that the UK restricts its liability to the amount derived from employment in the UK by means of time apportionment. In many cases, the new rules of Chapter 5A will mean that time apportionment under a treaty claim is not required because the UK’s domestic taxing rules achieve the same end. However, the effect of Chapter 5A apportionment is to make 'foreign securities income' assessable in the UK on the remittance basis, whereas treaty time apportionment exempts a proportion of specific employment income from a UK tax charge. Where this is the case, the relief available under the Treaty will take precedence over the rules of Chapter 5A. In addition, mismatches can occur between the apportionment required by the new remittance basis rules and that offered by a particular treaty and, again, the relief available under the treaty will take precedence.

Form 42 requirements

Events which need to be reported are listed at ERSM140100. These include, for example, the exercise of an employment-related securities option. If the remittance basis applies such that part of the option gain is foreign securities income, there is no obligation for the employer to report any subsequent remittances of that foreign securities income. However, the option exercise must be reported.