Transferring Employer National Insurance Contributions due on Equity Awards in the United Kingdom to Employees
July 21, 2022
With the introduction of a new Health and Social Care ("HSC") Levy in the United Kingdom on April 6, 2022, we wanted to take a few minutes to revisit a unique aspect of granting equity awards to employees in the UK: the ability to shift the employer's responsibility for paying National Insurance contributions ("NICs") on equity award income to the employees who receive the awards. This may be particularly important for companies that are already requiring employees in the UK to pay employer NICs due on their equity awards because they may need to revise any UK-specific provisions in their award agreements or existing NIC joint election forms to account for the HSC Levy once it becomes a stand-alone tax at the beginning of the 2023/2024 tax year.
A refresher on the process and potential benefits of transferring employer NICs
Under the Income Tax (Earnings Pensions) Act 2003 in the UK, employers and employees may agree that as a condition of accepting an equity award (including awards granted by a foreign parent company), the employees will pay part or all of the employer NICs due upon the relevant taxable event (e.g., upon exercise of stock options or settlement of RSUs for employees in the UK). So long as the employees pay the employer NICs due on their equity award income by July 6 of the UK tax year (which runs from April 6 to April 5) following the tax year in which the taxable event occurs, then the employees can deduct the amount of employer NICs they paid from their income tax liability on their equity awards for that tax year.
Employer NICs are due at a rate of 13.8% on annual income (including equity award income) greater than GBP 8,840. For the 2022/2023 UK tax year, however, this rate has been raised to 15.05% to include the new 1.25% HSC Levy. Once the 2023/2024 tax year begins on April 6, 2023, the HSC Levy will be broken out into a separate tax.
Because employer NICs are uncapped (i.e., they are not subject to an annual income ceiling), they can result in significant social insurance costs for companies granting equity awards in the UK. So shifting the employer NICs to employees can create cost savings for companies granting awards in the UK while allowing the employees to deduct the amount of the employer's NICs from the income tax liability on their equity awards (although we should note that the employees will ultimately pay more in taxes than they would have without the employer NIC transfer).
There are two different methods for transferring employer NICs to employees:
- By written agreement between the employer and employee (also known as transferring the employer's NIC obligation "contractually" or "by contract") – This can be done, for example, by including UK-specific provisions in a country appendix to an equity award agreement. However, two possible downsides to this method are that (i) the employer remains liable for the employer NICs if the employee does not pay them and (ii) it may raise accounting issues.
- By a joint election between the employee and the issuer (on behalf of the UK employer, if the issuer and UK employer are different) – This method requires drafting an election form that must then be approved by HM Revenue and Customs ("HMRC") and into which the employees and an authorized representative for the issuer (or the UK employer, as applicable) must enter. Some of the benefits of using this method versus the contractual method are that (i) the employer will not be primarily responsible for paying the employer NICs if the employee ultimately fails to pay (although HMRC may still seek payment from the UK employer if the employee fails to pay) and (ii) this approach should not raise the same accounting issues.
The vast majority of US issuers we work with that require UK employees to pay the employer NICs due on their equity awards transfer the employer's obligation using an HMRC-approved joint election form.
If a company decides to transfer employer NICs, the company will need to work with its local payroll team in the UK to ensure that amounts are withheld from the employees to cover the employer NICs at the time of the taxable event. For example, this can be done by calculating a maximum combined withholding rate that includes the maximum income tax and employee NIC rates (based on the assumption that all employees are in the highest income tax bracket) plus the maximum employer NIC rate, and applying that rate when executing sell-to-cover transactions for tax withholding purposes. Any amounts that are over-withheld as a result of using such a maximum combined rate (i.e., because an employee is in a lower income tax bracket, thereby resulting in a lower individual withholding rate for the employee) are then trued up to the employees through local payroll.
During the 2022/2023 tax year, companies that are already transferring employer NICs to employees (whether by contract or by joint election) should be able to rely on existing contractual language or joint election forms to transfer the full amount of employer NICs due on equity awards, including the 1.25% increase meant to capture the new HSC Levy. But companies should review the UK provisions in their award agreements or joint election forms with their legal counsel to confirm that the language is broad enough to cover the increased rate.
Once the HSC Levy is broken out into a stand-alone tax starting with the 2023/2024 tax year, the current legislation indicates it should be possible to transfer the HSC Levy (in addition to the standard employer NICs) to employees as a condition of accepting an equity award. However, companies will likely need to revise UK-specific provisions in existing award agreements and joint election forms to include the HSC Levy, depending on whether HMRC issues further guidance on this before April 6, 2023.
Frequently asked questions
For companies that are granting awards in the UK for the first time (or that have granted in the UK before but are thinking about transferring employer NICs for the first time), we are often asked these questions about the process:
How many companies transfer employer NICs due on equity awards to UK employees?
This number generally depends on what award type is being granted. Based on the last survey we conducted among our clients on this question in 2018, 59% of respondents said they were transferring employer NICs due on RSUs; 36% said they were transferring employer NICs due on stock options; 18% said they were transferring employer NICs due on ESPP income; and 8% said they were transferring NICs due on restricted stock awards. Those percentages generally align with what our group continues to see in the current market.
If we decide to transfer employer NICs using a joint election, do we need to wait for HMRC to approve the joint election form before we make any grants in the UK?
The company's Board of Directors (or Compensation Committee or relevant delegate, as applicable) can approve grants in the UK before HMRC approves an election form, especially if employer NICs are transferred contractually. If employer NICs are transferred by way of a joint election form, we understand the joint election form must have at least been submitted to HMRC at the time the grant is approved, in order for the company being able to avoid having to book an expense for the employer NICs. Further, ideally, companies should wait until HMRC approves the form before asking the employees to accept their award agreements and enter into the election to ensure maximum enforceability of the election. We typically see companies wait to communicate grants and distribute award agreements to employees in the UK until after HMRC approves the election form so that the companies can ask the employees to enter into the election at the same time they are asked to accept their award agreements.
Do we need to have the UK employees sign a joint election form in hard copy with a wet signature, or can the employees enter into the election electronically?
Both approaches are possible, but we typically see companies ask employees to enter into the election electronically. In that case, specific language must be included in a UK-specific country appendix to the award agreement and in the joint election form to provide for electronic acceptance. In general, it must be clear to the employee electronically accepting the joint election that they are doing so (e.g., by highlighting that acceptance encompasses not only the grant acceptance but also the joint election).
If we want to grant awards in the UK now but are not sure yet whether we want to transfer the employer's NIC liability, can we require the employees to pay the employer's NICs at a later time?
If a company is unsure whether to actually transfer employer NICs, it should include UK-specific provisions in a country appendix to an award agreement requiring employees to pay the employer's NIC liability (by contract or by joint election). If (by the time of the taxable event), the company decides it does not wish to transfer the employer NICs, it can waive this requirement. Because this modification is beneficial to the employee, it does not require consent. Companies should, however, check on the accounting implications of waiving the employer NIC transfer.
Can private companies transfer employer NICs to employees in the UK?
However, in many (but not all) cases, income realized from equity awards granted over a private company's shares will not be subject to employee or employer NICs if the company's shares are not considered to be "readily convertible assets" ("RCAs") at the time of the relevant taxable event.
A full analysis of when a company's shares are RCAs is outside the scope of this article. But generally speaking, a private company's shares are considered to be RCAs (i) once the company starts taking meaningful steps toward an IPO (e.g., filing a confidential Form S-1); (ii) when other trading arrangements are put in place (e.g., a tender offer to purchase the company's shares from employees); or (iii) if the ultimate holding company above the private company is also unlisted.
Further, because the shares underlying a private company's equity awards could become RCAs by the date of the taxable event even if the shares are not RCAs on the grant date (e.g., if stock options over a private company's shares are not exercised until after the company becomes publicly listed), there may still be an incentive for the company to take steps to shift employer NICs to UK employees for awards granted while the shares are not RCAs.
If we engage individuals in the UK using an employer of record/professional employer organization (PEO), is it still possible to transfer any employer NICs due on equity awards granted to the PEO workers?
Yes, so long as the award agreements and joint election forms are carefully drafted to capture the relationship between the issuer, the PEO and the PEO workers. However, as we previously wrote about in our April 2022 blog post, we often see that many PEOs are unable (or unwilling) to discharge applicable tax withholding obligations for equity awards, which could complicate the ability to transfer employer NICs to PEO workers.
Given the potential tax savings for issuers and the prevalence of companies transferring employer NICs for at least some award types (e.g., RSUs), requiring UK employees to pay any employer NICs due on their equity awards can be an attractive choice for many issuers.
In light of the new HSC Levy, companies that are already transferring employer NICs should review their award agreements and joint election forms with their legal counsel to ensure that they can transfer the full NIC obligation during the 2022/2023 tax year (while the HSC Levy is included in the employer NIC rate) and after the 2023/2024 tax year begins (at which point, the HSC Levy will become a stand-alone tax).
For companies that are considering whether to transfer employer NICs for the first time, they should:
- decide the method by which they will transfer the NICs (i.e., by contract or by joint election);
- work with their legal counsel to include UK-specific terms and conditions in an appendix to the companies' award agreements;
- draft a joint election form to submit to HMRC for approval (if the NICs will be transferred by joint election), ideally before any grants are made and/or communicated to UK employees;
- establish a process by which employees will be asked to enter into (whether by wet signature or electronically) the joint election (if the NICs will be transferred by joint election); and
- establish a process by which the UK employer/local payroll will withhold amounts to cover employer NICs due on the equity award income from the UK employees.
Global Equity Services