The Government is this week expected to cave in to pressure from the world's most powerful IT companies and rewrite a tax plan introduced less than a month ago.
Stephen Timms, the Financial Secretary to the Treasury, is to announce that companies will be freed from a 12.2 per cent National Insurance tax on employee share options.
A well-placed source revealed that the tax burden will instead be shifted to the employee. However, to lessen the sting, Mr Timms is also working on a tax-relief plan, under which employee National Insurance payments on shares could be cut by up to 40 per cent.
The move will be an embarrassment to the Government, which introduced the tax in last April's Social Security Bill.
A source close to the Treasury said: "They just realised that they had messed up and are going to have to put a brave face on it."
The policy U-turn may require the creation of new legislation. Therefore, ministers are preparing to draft an amendment to the Child Support Bill, which is high up the legislative time scale and covers social security issues. The amendment could be proposed when the bill gets its next reading in the House of Commons, scheduled for the second week of May.
IT companies, including Cisco, Microsoft and Oracle, were enraged when the tax was introduced. They claimed that because most companies in the sector use share options as a recruitment tool, it would be near impossible to budget for the extra tax.
The concern triggered a major industry lobbying campaign, which was headed by a trade organisation, the Computing Services & Software Association (CSSA). On Friday, it submitted its final report to the Treasury, documenting the impact the tax would have on the UK. This could include companies choosing to set up base in continental Europe rather than in the UK, and UK entrepreneurs listing share options offshore.
Tim Conway, a CSSA director, said: "The problem is that the tax burden is not fixed as it relates to the value of the shares. With the current swings in stock prices, it is near impossible for a company to budget for it."
He added that smaller dot com companies could be worse hit. "If you have a company which makes just £500,000 profit but trades at a good premium, then its National Insurance bill could be as high as £1m," he said.
The Independent on Sunday also revealed earlier this month that Cisco, the world's largest company, was prepared to pull out of a multi-million pound UK investment plan because of the tax.
If the Government decides to shift the tax liability to the employee, it is unlikely to be greeted with universal applause by the IT sector.
While the companies won't have budgeting uncertainties, the share options will become less valuable to the employee because of the tax. This could force IT companies to issue more share options to compensate.
There is also talk of some companies channelling future investment towards Ireland, where share options are free of the National Insurance tax.
Norman Green, finance director of Oracle UK, said: "National Insurance on stock options is a major cost to the IT company, which is putting the UK at a competitive disadvantage when compared to places like Ireland."
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