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Company Formation Home Page >> UK Tax Planning >> The Taxation of Share Options | 
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THE TAXATION OF SHARE OPTIONS: INTERNATIONALLY MOBILE EMPLOYEES Share options. Share incentives available to internationally mobile employees can take various forms. This article is about share and stock options. Employees can be granted options to acquire shares in their employing company or a company in the same group. Typically the employee is granted options to acquire a specified number of shares at a price fixed at grant - the "option price". This may be set at the market value of the shares at the date of grant or at a lower figure. The option will then be exercised some years later, when the employee buys shares at the option price. The shares then belong to the employee and can usually be immediately sold.
Domestic legislation. The UK tax treatment of such options in the hands of the employee depends on factors such as: whether or not it was granted under a plan providing income tax advantages - the Inland Revenue approved Company Share Option Plan or a SAYE share option plan within Schedules 9 and 10 Income and Corporation Taxes Act (ICTA) 1988, or an Enterprise Management Incentive (EMI) option within Schedule 14 FA 2000. The employee's residence status at the dates of grant and exercise. The period over which the option can be exercised. Whether the option was granted at a price below the market value of the shares at the time of grant.
This article is concerned only with options granted under an unapproved share option plan and non-qualifying exercises of options granted under an Inland Revenue approved plan. A "non-qualifying" exercise here means one where the conditions for income tax relief have not been followed, such that there is an income tax charge. An EMI also provides income tax exemption on the exercise of certain share options, but income tax may be due if the options were issued at a discount to the share price or there has been a disqualifying event. To the extent that gains on such options remain in charge to income tax, this article applies to them in the same way as to unapproved share options.
There will normally be UK income tax implications only if the individual was resident in the UK at the date of grant, or the option was granted in respect of duties carried out in the UK. As the option over the shares is acquired by reason of employment a tax charge may arise under Schedule E at: The date the option was granted. The date the option was exercised; or the date the shares acquired at exercise are disposed of. Capital gains tax may be due where gains on the disposal of shares are greater than the gain chargeable to tax under Schedule E. Examples are where: the sale price exceeds the exercise price, or the individual was not resident in the UK at the date of the event.
Capital gains tax may arise where individuals are either resident or ordinarily resident in the UK at the date of disposal or if they are within the scope of the temporary non-residents rules contained in Section 10A, Taxation of Chargeable Gains Act (TCGA ) 1992. There are special rules for the tax year of commencement or cessation of residence and for non-UK domiciliaries. A UK tax charge may be triggered by other events, such as the assignment or release of an option to acquire shares, or the conversion of shares acquired by reason of employment from one class of share into another class of share. This article cannot cover every possible situation but guidance about circumstances not dealt with here is available from the contacts listed at the end.
INTERACTION WITH DOUBLE TAXATION AGREEMENTS If the employee moves between countries a tax charge may also arise in another country when the option is exercised, assigned or released. This article sets out the Revenue's current practice for dealing with possible double taxation in the most common scenarios. The UK is actively involved at the Organisation for Economic Co-operation and Development (OECD) with their work on reaching a common international consensus on the treatment of share option gains.
If there is no Double Taxation Agreement (DTA) with the other country then both countries are free to tax income in accordance with their domestic laws. In some circumstances, however, the United Kingdom will grant its residents unilateral relief in respect of foreign tax suffered on income that arises in another country but is taxed in the UK on the basis of residence. However if a comprehensive DTA exists it will normally have an employment income Article along the lines of Article 15 of the OECD Model Tax Convention. Gains realised from the exercise of options granted to an employee fall within the provisions of this Article rather than those Articles that deal with other income or capital gains.
Article 15(1) provides that if a resident of one country performs the duties of his employment in the other country, then the latter country retains any domestic rights to taxation of remuneration and benefits from that portion of the employment. To avoid double taxation, where an employee: was granted a share option in the UK during the course of an employment. Exercised that employment in the other country during the period between the grant and exercise of the option. Remains in that employment at the date of the exercise and would be taxed by both of them in respect of the option gain. Is not resident in the UK at the date of exercise; then the UK will give relief in calculating the tax charge for the proportion of the option gain which relates to the period or periods between the grant and exercise of the option during which the employee exercised the employment in the other country.
The gain will normally be time-apportioned on a straight-line basis. Periods not in that particular employment are left out of account so that the apportionment is still made on the basis of relative periods of employment in each country. Very occasionally this may not provide a sufficiently accurate apportionment. If so, another method may be used provided this does not produce double taxation or lead to income going untaxed in either country. In other cases credit relief may be appropriate.
In the following examples: all the share option plans are unapproved. All references are to the Income and Corporation Taxes Act 1988 (ICTA) unless otherwise stated. There is a comprehensive DTA with the overseas country containing a provision along the lines of Article 15 of the OECD Model.
Example 1. Mr. A is resident and ordinarily resident in the UK and working here on 1 January 1997. On that day he is granted an option to purchase 1,000 shares in the company in four years' time at the 1 January 1997 market price of Ј1. On 1 January 2001 he is moved to another country and is still in the employment there when the option is exercised on 1 January 2002. At that date the shares are worth £5 each.
A is resident and ordinarily resident in the UK at the date of grant and is therefore liable to income tax under Section 135 on any gain realised at exercise. The gain is calculated as the difference between (a) the value of the shares at the date of exercise and (b) the option price paid plus any consideration given for the option itself; in this case the gain is 1,000 x £4 = Ј4,000. The charge falls to Schedule E generally [Section I35(1),] rather than through any of the Cases of Schedule E and, as such, it arises regardless of the individual's residence status at the date of exercise.
Since the date of grant the employment has been performed in the UK for 4 years and in the other country for one year. 80% of the gain (£3,200) will therefore be assessed in the UK and 20% (£800) will be regarded as attributable to the other country.
The exercise of the option will be within the scope of PAYE by virtue of Section 203FB if the shares are readily convertible assets (see Tax Bulletin Issue 36, August 1998). Under Section 203F(3) the amount on which PAYE should be operated is the amount which, on the basis of the best estimate that can reasonably be made, is the amount of income likely to be chargeable to UK income tax. So if the employer has sufficiently accurate information on periods of employment spent abroad they may be able to operate PAYE for the non-resident employee only on the UK proportion.
Example 2. The facts are the same as for example 1 except that A takes the whole of 1998 as a sabbatical year when he does not exercise his employment anywhere. Four years have been spent in employment over the period between the grant and exercise of the option. The total gain in value of £4,000 is apportioned 75% to the UK and 25% to the other country.
Example 3. Mr. B is resident and ordinarily resident in the UK and working here on 1 December 1996 when he is granted a share option. He works overseas during 1997. He returns to the UK on 1 January 1998 and is still in the employment here when he exercises the option on 1 January 2001.
As B is not resident in the other country either when the option is granted or when it is exercised it is very unlikely that any tax could be charged there in respect of the share option. As he is resident in the UK at both grant and exercise, the UK will tax the whole gain. If any tax has been paid in respect of the option in the other country for the year spent working there then the UK will give credit for this against the Section 135 charge.
Example 4. Mrs. C is resident but not ordinarily resident in the UK when an option is granted. She is still resident in the UK when she exercises the option and sells the shares. At the time of grant the UK charge in respect of the employment is not under Case I of Schedule E therefore Section 135 will not apply. C will be liable to UK income tax under Section 162(5) at the time of disposal of the shares. The charge is on the difference between the market value of the shares at the time of exercise less any amounts paid. This is treated as a notional loan written off within Section 160(2) and as emoluments of the employment.
If an individual is resident in the UK at both the date of grant and the date of exercise the UK will have primary taxing rights even where a treaty partner country wishes to tax the gain under its own domestic legislation. However a claim under the employment income Article of the DTA may be relevant if the duties of the employment have been carried out in the other country during the period between grant and exercise of the option and double taxation has occurred. C may, however, be liable to UK capital gains tax on any gain she makes on selling the shares acquired by exercising the option. Her allowable cost will be the total of the amounts she paid for the option and shares together with any amount charged to UK income tax under Section 162(5). There are special capital gains rules for non-domicilairies at Section 12, TCGA 1992.
Example 5. Mrs. D is not resident and not ordinarily resident in the UK when her employer grants her an option to purchase shares. At some time before exercise she moves to the UK and performs the duties of the employment there. She exercises the option when working in the UK and sells the shares. D will not be liable to UK income tax on any gain realised at exercise, unless the grant of the option is clearly related to duties performed in the UK. In this case there could be a liability under Section 162 although all relevant facts and circumstances would need to be considered before determining whether or not a liability arises.
She may, however, be liable to UK capital gains tax on any gain realised as a result of selling the shares acquired following the exercise of the option. This would be so if she is either resident or ordinarily resident in the UK at the date of disposal or if she is within the scope of the temporary non-residents rules contained in Section 10A, TCGA 1992. There are special capital gains rules for the tax year she commences UK residence and for the case where she is a non-UK domiciliary. D's allowable capital gains cost would be the total of her payments for the option and shares together with any amount charged to UK income tax under Section 162(5).
Even though exercise will not normally trigger a UK income tax liability in this case, it may well give rise to a tax charge in another country. Strictly, the exercise of the option and the subsequent disposal of the shares are two distinct events and the UK is not obliged to allow a foreign tax credit for any foreign tax paid on exercise against any UK capital gains tax payable on disposal. Nevertheless, where tax has been paid in a treaty partner country, we will treat all or part of the gain as falling within the provisions of the employment income Article of the relevant double taxation agreement and allow the relevant proportion of the foreign tax paid as a credit against the UK capital gains tax: If the options are exercised and the shares sold on the same day, the whole gain is treated as falling within the provisions of the employment income Article of the relevant DTA. If the shares are disposed of at a later date, part of the gain may be treated as falling within the employment income Article of the agreement. All the facts and circumstances in a particular case will be considered and the tax treatment will depend on such factors as whether the share price has increased or decreased, or whether there have been significant changes in the share price since exercise. We will allow a proportion of the foreign tax paid as a credit against UK capital gains tax normally calculated on a time apportionment basis by reference to periods of employment abroad. It does not matter whether the foreign tax was charged on grant, exercise or some other occasion. The credit for foreign tax can never exceed the UK tax payable on the relevant proportion of the total gain.
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Tax Planning
The Taxation of Share Options
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