Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

The purpose of the clause is to extend the opportunity for employers to ask their employees to bear the employer's national insurance liability that may arise some time after an award of restricted or convertible shares, but which cannot be quantified when those shares are awarded. The clause does not introduce anything new; rather it extends the use of a facility that has been used by employers and employees with respect to earnings from share options since its introduction in 2000. The facility to allow employers and employees to agree to transfer the employer's national insurance liability arising from share option gains has been widely welcomed and successfully used by many employers. More than 1,800

employers have applied to the Inland Revenue for approval to use that transfer facility for employees receiving share options.

The Government keenly support the measures that encourage employee share ownership. Research shows that there is a link to improved productivity. The Government also provide significant income tax and national insurance reliefs when businesses award shares to their employees through one of several Inland Revenue-approved schemes. Such reliefs amount to more than £1 billion a year and affect about 2.5 million employees. Employers do not have to limit themselves to such tax and national insurance advantage schemes. However, any awards to employees that are outside the limits and rules of such approved share schemes will, like any other form of earnings from employment, attract income tax and national insurance liabilities.

Perhaps it would be helpful if I briefly explained the history to the relevant facility. In 1999, the Government aligned the national insurance treatment of share options with income tax treatment, so that both income tax and national insurance liabilities arise when the employee exercises the option and acquires shares. However, for some employers that led to accounting difficulties. Following consultation with those affected businesses, the Government introduced a technical solution to allow employers, with the consent of their employees, to transfer any employer's national insurance liability that arose on share options earnings to the employee receiving those earnings.

In 2001, the Government again demonstrated that they had been listening to the concerns of the business community by introducing legislation to give employers the opportunity to crystallise their employer's national insurance liability to share options granted between 6 April 1999 and 19 May 2000. That was done to meet the needs of employers who faced unpredictable national insurance liabilities on the exercise of share options, but who were unable to take advantage of the facility to transfer the employer's national insurance liability to the employee.

In continuing discussions with employers, we have become aware of the increasing attractiveness of restricted and convertible shares as a form of incentive that employers could use to motivate and reward their employees. However, employers and their representatives have said that problems in accounting for the employer's national insurance contributions on share-based earnings are not limited to share options. Employers also face difficulties in accounting for the employer's national insurance liability that may arise as a result of certain events following the award of restricted and convertible shares.

Those difficulties arise because the national insurance charge may be triggered by certain events that occur after the shares are acquired by the employee. Such events are commonly referred to as post-acquisition chargeable events, and they include the lifting of restrictions applying to the shares or the conversion of shares to another more valuable form of

shares. Because of the time gap between the award of the shares and the post-acquisition chargeable event, and the unpredictability of changes in the share value during that period, the consequent size of the national insurance liability arising on post-acquisition events is also unpredictable.

Clause 3 provides a technical solution for employers who face unpredictable national insurance liabilities on awards of restricted or convertible shares. The solution is similar to that currently available for share options granted to employees; as I have said, more than 1,800 employers have already made applications to take advantage of that facility. By extending the facility to transfer employers' national insurance liability to post-acquisition earnings from restricted and convertible share awards, the measure will give employers greater flexibility in choosing how to use shares to motivate and reward their employees.

I shall be happy to respond to questions from the hon. Member for Hertford and Stortford, but I must again make it absolutely clear that the clause is intended to provide options to allow employers to continue to provide—or, in some instances, to begin to provide—share options to their employees, ensuring that they are protected with regard to the unpredictable national insurance liabilities that may subsequently arise.

Mr Mark Prisk (Hertford & Stortford, Conservative)

I welcome the Paymaster General's opening remarks. As she said, the clause widens the scope of joint national insurance elections and agreements to deal with convertible and restricted securities. The right hon. Lady highlighted the fact that the benefit of the provision to the employer is that it removes the risk of unpredictable and unanticipated post-acquisition secondary liabilities for national insurance. In some cases, such liabilities can be significant. They may therefore have an impact not only on the employer's profitability, but just as significantly—in some cases, more so—on their cash flow. Those Committee members who have been in business understand that cash flow is often more important than profitability.

As clause 3 is intended to remove barriers to widening share ownership, Conservative Members warmly welcome it, although, as I suspect the Paymaster General will have anticipated, I have a couple of questions about the practicalities and the costs of the clause and the contents of the supporting documentation. I refer in particular to the regulatory impact assessment, which relates, first, to the cost of agreements. Page 5 states:

''Any costs will primarily be associated with drafting a suitable agreement, asking employees to enter into these agreements and ensuring the secondary NICs are recovered from the employee correctly.''

That is fine. The assessment continues:

''However, most employers are likely to incorporate suitable wording into their existing share scheme documents and any cost will become part of the overall cost of setting-up and operating employee share schemes.''

On the face of it, that is fine, but it would be helpful if the Paymaster General could tell us what estimate the Treasury has made of the costs for employers. That is

not elaborated in the assessment, and it is difficult for us to understand the scope, and therefore the implications, of the cost of the agreements.

There is a slight contrast between that matter and the joint elections, on which the assessment is slightly clearer. However, there are still some unclear statements. The next paragraph on page 5 states:

''An employer may incur initial costs for seeking professional advice on preparing a form of election and obtaining Inland Revenue approval and it is estimated this service may cost around £3,000.''

What is the basis of that calculation? In particular, is that per application or per employee? That makes a quite significant difference to a large employer. The assessment goes on to state that the Revenue

''will provide a model form of election'',

and that is welcome. However, it then makes a rather unsupported assertion:

''Additionally, the benefits of a joint election to the employer will outweigh this initial one-off cost.''

That is fine, but perhaps the Paymaster General could explain how that will happen. The assertion seems to be made without any evidence behind it. The Paymaster General will know that I like to make sure that I am clear about the evidence for that kind of assertion.

Can the Paymaster General confirm, pursuant to what I have explained, that the impact on businesses is approximately £1.5 million, on the basis of the figures given: the stated 500 applications and a figure of £3,000 per service. However, perhaps I am misreading things.

On the question of joint elections, I suspect that the error is unintentional, but there is a reference in the relevant paragraph to secondary national insurance contributions being paid by the employee. Of course, employees pay only primary national insurance contributions. I did not quite understand that sentence; I hope that it is just a typographical error.

I want to refer to two aspects of the matter that shape clause 3. Clause 3(2)(b) would insert a new sub-paragraph (2A) into paragraph 3A of schedule 1 to the Social Security Contributions and Benefits Act 1992: that new sub-paragraph includes the term ''artificially depressed market value''. Had this sitting commenced at five minutes to 9, most of us would have been suffering from an artificially depressed market value. However, will the Paymaster General define the term and how the provision will be enforced? Clearly, the market value of the securities will be critical to the whole clause, or indeed the Bill. A definition to show when something has been artificially depressed and when it has not will be helpful. I am sure that it is in the legislation that has been mentioned, but as I am sure the Paymaster General will appreciate, many elements of legislation are affected or amended by the Bill.

By contrast to the term ''artificially depressed market value'', the phrase ''relevant employment income'' is somewhat over-generously defined in the new sub-paragraph (2B) set out in clause 3(2)(b).

Rather than having no definition, we appear to have three. We are told that it means, in relation to the earner,

''an amount that counts as employment income of the earner under section 426 of ITEPA 2003'',

''an amount that counts as employment income of the earner under section 438 of that Act''

or that it is

''a gain that is treated as remuneration derived form the earner's employment by virtue of section 4(4)(a) above.''

I assume, although one should not make assumptions about a Bill, that there should be an ''or'' between (a) and (b); otherwise there is potential for the clause to be misread. No doubt it is an oversight, but I hope that the Paymaster General will clarify it.

Mr Norman Lamb (North Norfolk, Liberal Democrat)

We, too, welcome the intention behind the clause. There is clearly a case to be made that the existing arrangements act as a disincentive to employers to offer to employees such remuneration as restricted or convertible securities. Can the Paymaster General indicate what estimate her Department has made of the impact of the extension of the rules to cover restricted and convertible securities? What will be the extent of their use, in the Treasury's estimation?

Secondly, the regulatory impact assessment states that a model form of election will be provided on the Inland Revenue website. Can the right hon. Lady confirm that that will be the case, and that it will be there before the rules come into force? We often hear about things not being available when they are needed. The hon. Member for Hertford and Stortford asked for clarification of what is covered by the term

''securities with artificially depressed market value'',

and I shall be equally interested in the Paymaster General's response.

The regulatory impact assessment also refers to the fact that the effect would be a £15 million transfer from employees to employers by virtue of the employees taking up the burden of paying the secondary contributions. I shall be interested to know how that assessment was made. What is the science behind it and how robust is it? Equally, on the same issue, the regulatory impact assessment identifies, in terms of risks of the legislation, the fact that security-based remuneration may not provide a sufficient incentive for employees if the total income tax and national insurance contributions burden that they face is increased to include secondary national insurance liability. The assessment rates that risk as low. I should be grateful if the Paymaster General could justify that. I believe that it is likely to be the case, but why is it assumed that it will not put employees off going for such remuneration?

There is also stated to be a risk of employees defaulting on obligations to pay secondary national insurance contributions. How does the Treasury assess that risk as low? The Inland Revenue would lose out because it would not be able to recover them from the employer. There could be circumstances in which an employee moved out of its jurisdiction—the hon. Member for Hertford and Stortford has referred several times to employees moving abroad—so,

although that person was liable to pay the secondary contribution because of the agreement or election, the Inland Revenue would have lost the opportunity to recover it from him or her and would not be entitled to recover it from the employer. Is the risk really as low as the assessment claims?

Finally, the regulatory impact assessment says, at page 16, that the Treasury has

''set up compliance mechanisms to ensure the employer has a vested interest in the employee meeting the liabilities''.

It then says that the employer will not be able to make joint elections again if the employee defaults. Is that the compliance mechanism? Is it as simple as that: if there is a default, is the employer prevented from ever entering a joint election again, or do other aspects of the compliance mechanism impose an incentive on the employer to ensure that the employee meets the obligations in place of the employer?

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I congratulate the hon. Member for Hertford and Stortford on spotting two typos. He was quite right when he referred to the ''or'' at the end of new paragraph (2B)(b) in clause 3(2)(b). The ''or'' is unnecessary. As for his reference to the regulatory impact assessment, the clause transfers the employer's secondary national insurance contributions to the employee. It is gratifying to see how carefully he scrutinises every piece of work.

It might help to answer first the questions from the hon. Members for Hertford and Stortford and for North Norfolk about the election. The Inland Revenue will want to ensure that, as regards what the employer has done, the employee understands their liabilities as contained in the joint election. In order for the joint election to transfer secondary contributions from the employer to the employee and for that to be approved by the Inland Revenue, it must contain statements that clearly inform the employee of the purpose and effect of the election and how it will be put into practice when a particular chargeable event occurs. The election must also include a declaration by both the employer and the employee that they will be bound by the terms of the election.

Schedule 5 of the Social Security (Contributions) Regulations 2001 provides that the approved election must contain the following statements. It must specify that it is for transferring the employer's national insurance liability on share options granted to the employee, and it must specify the details of the options to be covered by the election and that the election has to be limited to share options. A statement and explanation of the effect of the legislation at section 4(4)(a) of the Social Security Contributions and Benefits Act 1992 is required, which ensures that the employee is asked to pay only the secondary national insurance liability that arises on gains from share options granted to him or her. It must state the amount or proportion of the employer's contribution that the employee will bear, including an acknowledgement that the liability was originally that of the employer and that the employee will now pay it.

Mr Norman Lamb (North Norfolk, Liberal Democrat)

I am conscious from my former life as an employment lawyer that, under the legislative arrangements for compromise agreement, when employees leave employment and sign away their legal rights, they have to have independent legal advice in order for the agreement to be effective. In the situation before us, we have a scenario in which the employee is asked to take over what is potentially a substantial financial burden from the employer. I understand from what the Paymaster General is saying that the agreement, or election, has to set out clearly the implications so far as the employee is concerned. However, we are all aware that employees as individuals often sign up to things without reading the small print. What protection is there to ensure that employees actually understand the information, rather than its simply being in a document that they have signed? They should understand the implications of what they are signing.

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

It is important to remind the Committee of the Bill's purpose. Where an employer gives an employee a substantial advantage by transferring shares of a value, it is subject to normal national insurance and tax, if that is outside the approved schemes, and the employee stands to make substantial gains, and the reason why the employer wishes to transfer the shares is based on the clear advantages in companies where employees are—

Mr Norman Lamb (North Norfolk, Liberal Democrat)

Will the Paymaster General give way?

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Just a minute. I am coming to the hon. Gentleman's point.

We are not talking about the Government forcing or regulating contractual relationships between employees and employers. We seek to do that which the hon. Gentleman impressed on the Government that it was important to do: ensure that the tax and national insurance systems should not impede any desirable relationship between employers and employees. Both employees and employers need to be clear about what they are signing up to with the transfer of liability.

In answering the hon. Gentleman's question, I will explain what the Inland Revenue will look for when it tries to ascertain that an agreement is valid and that it has a document that legally transfers the liability for the insurance, thereby changing whom it pursues for that liability. If employers wish to do that, because they see all the advantages of share ownership, it will be for them to make sure that they have proper agreements that will satisfy the Inland Revenue, as it will be for employees to ensure that they understand the full extent of their responsibilities before they take them up.

I will make my final points about what employers must do before looking at the issue of coercing employees, and what we have tried to do with that. Even though such issues are, strictly speaking, contractual matters between employees and employers, it may help.

Mr Norman Lamb (North Norfolk, Liberal Democrat)

I appreciate the Paymaster General going through this in detail. The benefit may not be as substantial as the right hon. Lady described in her response to my intervention. Employees may be persuaded to take share options or other forms of securities in lieu of an increase in wages, so there could be all sorts of situations in which employees are under pressure. I want to ensure that the wording of what employees sign is sufficiently clear and that it is presented sufficiently clearly for them to understand what they are signing—a full acceptance that they are receiving a benefit that may be in lieu of some other benefits that they thought that they were going to get.

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I shall return to that point with regard to employees. First, I give way to the hon. Member for Hertford and Stortford.

Mr Mark Prisk (Hertford & Stortford, Conservative)

That was a useful exchange, although it may be tangential to the essence of the clause. I was, however, slightly concerned that the Paymaster General seemed to be implying that share options can only be more beneficial than cash. She might want to append her remarks, because she will know, as we all do, that the value of shares can go down as well as up. I just want to give her the opportunity to say that.

Mr Rob Marris (Wolverhampton South West, Labour)

Do not exercise the option.

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Precisely so, although I agree with the hon. Member for Hertford and Stortford. Neither the Government, nor I as a Minister, nor the Contributions Agency, are trying to place ourselves between an employee and an employer by deciding where their best advantage lies. I am simply responding to the point made to us that the workings of national insurance impede that clear understanding.

Within the limited scope of national insurance, the Bill's aim is to remove those perceived barriers and to leave the employee and the employer to settle important and possibly complex issues. It would be the nanny state to the nth degree if we were to go down the route that the hon. Members for North Norfolk and for Hertford and Stortford seem inadvertently to be trying to encourage me to go down, which is almost to the point of giving financial advice to employees about whether they would be wise to take share options. We are not doing that. It is for the employee to decide.

We have accepted that liability can be transferred from employer to employee. Given that, and taking into account the current principle of national insurance, if in this exceptional circumstance the Inland Revenue has all the information that it needs to see that the arrangements are being properly used, we must ensure that it can pursue someone for some or all of the liability according to a clear point in law, and that there are necessary safeguards, as we would expect in any provision, that do not substitute themselves for an employee deciding, rightly or wrongly, whether to take up a share option when it is offered.

As I said, the agreements must specify whether the employer pays all or part of the national insurance liability. The employer is also required to explain the process by which he will recover the transfer of

national insurance liability so that the employee is aware of what will happen when the gain from the share option occurs. That will ensure that both parties to the election are aware that the election comes to an end once its terms have been satisfied, or once it is agreed that it should no longer apply.

The hon. Member for Hertford and Stortford asked me about the £3,000 per application and the costs to employers. I confirm that the Inland Revenue will submit a draft agreement by the time the legislation becomes operational. Our experience, however, seems to indicate that employers will take their own legal advice and draft their own agreements. The Inland Revenue will need to be satisfied that those agreements, within the very brief outline that I set out, are within the legislation. Again, employers will decide whether or not they want to carry that cost, as it will be part of their decision whether or not to offer share options. They will also decide whether or not the unpredictable gain, should there be one, is greater and therefore whether it is more sensible for them to move to these arrangements.

We need briefly to touch on how the Inland Revenue will try to ensure that the employer will explain to the employee what joint election is and what its purpose is. It must be approved by the Inland Revenue and must contain statements that clearly inform the employee of the purpose and effect of the election, and how it will be put into practice when a chargeable event occurs. Schedule 5 of the Social Security (Contributions) Regulations 2001 provides that an approved election must specify that it is transferring the employer's national insurance liability on share options granted to the employee. The election must be limited to share options and must ensure that employees are being asked only to pay the secondary national insurance liability that arises on gains from share options granted to them. The election must specify whether the employee will pay the whole or part. The employer is required to explain to the employee the process by which he or she will recover the transferred national insurance liability.

What happens where there is an allegation of coercion? Although it is difficult to envisage the circumstances, if a dispute were to arise because an employee felt that they had not freely entered into the joint election, the Inland Revenue has powers to withdraw approval of the continued use of that election. It would then be up to the employee to make the case to the Inland Revenue. However, given what must be in the agreement—the employee should have read it and the unpredictability of the gain should have been explained to them—they will need to demonstrate clearly how they signed a piece of paper that said that they understood, when in fact they did not.

Mr Norman Lamb (North Norfolk, Liberal Democrat)

It seems as if the Inland Revenue has properly addressed the issue of coercion with regard to share options, and I am interested to hear that it can withdraw its consent if there is evidence of coercion. Is any information available on whether those powers

have been used with regard to share options? Is there any evidence of employees complaining of employers improperly coercing them into agreeing to such elections?

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

No, there is not, but it may be a question of waiting until the gain is realised and the option arises. As I have stressed, liabilities have for some time been an important issue in discussions between employers and employees. To date, the Inland Revenue has been placed under pressure to extend the list of approved schemes to make things even easier, although there is a substantial cost to the taxpayer. That is not to say that the scheme was not working in a suitable fashion.

We shall keep an eye on the situation, although people are of course not slow to come to the Inland Revenue to offer advice, guidance and suggestions on how to change or develop the scheme. The Inland Revenue has done its level best—it has done well—to strike a balance between holding on to those important principles that operate for the national insurance system as a whole while yet removing in a reasonable way those difficulties that impede the development of another policy, which is widely encouraged by the House and is to the good of employers and employees.

The term ''artificially depressed market value'' is defined in chapter 3A of part 7 of the Income Tax (Earnings and Pensions) Act 2003, as amended by schedule 22 of the Finance Act 2003. I am sure that the hon. Gentleman will remember from our discussions on the 2003 Finance Bill that the creativity of some in the tax planning industry in using even a generous provision to squeeze more out of the system than was intended by Parliament seems to be without limit. It is not simply that share schemes or the transfer of other assets are used as a substitute for earnings in order to get around national insurance or PAYE requirements.

The term is firmly anchored in the operation of the tax system, and it will not be unknown to those who advise on share options or any other form of tax planning to companies or individuals. It is intended to ensure that employers and employees cannot avoid their full tax and national insurance liability by paying earnings in shares, the value of which has been deliberately manipulated to reduce that liability.

Mr Mark Prisk (Hertford & Stortford, Conservative)

I am not necessarily after a specific definition; I am aware of it, although I do not retain it at the forefront of my mind. Nevertheless, I am grateful to the Paymaster General for refreshing my memory. I wish to make a broader point.

It would be useful if such definitions were to be included in the explanatory notes. Being told that an explanation can be found in this or that Act does not always help. I do not ask for a definition of every phrase or word, although I am sure that the right hon. Lady and the Committee will understand that it can be quite helpful, particularly for hon. Members who come fresh to the subject. Rather, I wonder whether such a commitment could be made for future legislation.

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I certainly take the point. That could be said of just about everything that crosses my desk, whether it be an emergency announcement, the closing of an avoidance scheme or draft legislation. It is a sad fact of everyday life that tax legislation needs anti-avoidance provisions, because the ability to manipulate value in order to reduce liability is widely exercised.

The phrase is a longer description of the intent of Parliament. Anyone reading the Bill can clearly see that we mean the value of the shares at the point of transfer, but a better definition is needed. Nevertheless, I am happy to consider the hon. Gentleman's suggestion.

The hon. Member for Hertford and Stortford said that page 5 of the regulatory impact assessment shows that we expect about 500 applications a year for new joint elections. That is based on previous national insurance elections; we are not able to do more at the moment. We have been told by employers that there is a restriction in the barrier.

Mr Norman Lamb (North Norfolk, Liberal Democrat)

I also raised the issue of compliance mechanisms. The regulatory impact assessment refers to the fact that compliance mechanisms have been set up to ensure that the employer has a vested interest in the employee's meeting the liability. It then says that the employer would not be able to make another joint election. Is that the compliance mechanism, or is it broader than that? I want to understand any difference.

Ms Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I am sorry; I thought that I had dealt with that. The mechanism is broader than that. I was trying to demonstrate that that is one possibility, in that the text of the election must set out the arrangements for recovery from the employee. The Inland Revenue must be satisfied that those arrangements are robust and will work. They are the employer's responsibility. If they do not work, the Revenue's recourse is to the employer. For those operating substantial schemes, having their election suspended would be counter not only to their up-front investment in providing for the smooth operation of the scheme, as has been pointed out, but to their realising all the benefits that they would like. The crucial point is that the election itself must clearly lay out how the recovery arrangements will work, and the Inland Revenue must be satisfied that they will work in all circumstances.

The debate has been very helpful and detailed. I hope that I have dealt with all the points from both hon. Gentlemen.

Question put and agreed to.

Clause 3 ordered to stand part of the Bill.