BIM44415 - Specific deductions: employee share schemes: providing shares to employees: Cash Cancelled and Net Settled Options - Interaction with Deferred Remuneration
S1038, S1038A Corporation Tax Act 2009, S1288 Corporation Tax Act 2009
For schemes meeting the definition of an option at S1005 CTA09, S1038A(2) will deny a deduction for any share-based payment expenses arising unless shares are acquired.
Where an option is cancelled and replaced by a taxable cash award, or it is net settled and shares retained in order to satisfy the tax liability, S1038 will not apply to the amounts paid in place of the shares. Instead, S1038A(7) will disapply S1038A(2) in all periods (see BIM44411) in relation to those amounts.
S1288 CTA09 applies where an amount is recognised in the company accounts in respect of employee remuneration but is unpaid within a period of 9 months of the end of the accounting period in which the amount is recognised.
Where S1288 applies, it defers any deductions for employee remuneration until the period in which the remuneration is paid.
The remuneration is considered to have been paid when an amount is recognised which is, or is treated as, earnings for the purpose of Parts 2-7 (Income Tax Earnings and Pensions) Act 2003.
Share-based payment expenses are considered to be an amount recognised in respect of employee’s remuneration for the purpose of S1288.
Contractual (“Legal”) Options
The deferral of a deduction under S1288 is sometimes referred to as “rolling up” but for contractual options it is not possible to “roll up” share based payment expenses to the period in which the option is exercised (see BIM44410).
This is because the granting of the option itself is considered to be the benefit paid for the purpose of S1288 as it is characterised as earnings. This is explained at ERSM110010, ERSM110015 and in Abbott & Philbin [1961] AC 352. No actual liability arises on grant of an option, but this is because of a specific exemption to the charge at S475(1) ITEPA 2003.
As the granting of the option is considered to be earnings for the purpose of S1289(5), S1288 does not apply in any period to defer deductions for share-based payment expenses.
This means that on cash cancellation or net settlement, the share-based payment expenses which were recognised in earlier periods, to which S1038A(2) no longer applies, cannot be deferred (or “rolled up”) to the period in which the option was exercised or the cash equivalent paid.
Restricted Stock Units and Long Term Incentive Plans
The provision of shares under Restricted Stock Unit plans (RSUs) and Long Term Incentive Plans (LTIPs) will usually fall within the definition of “options” for the purpose of S1005 CTA09 (see BIM44410). But unlike contractual share options, there is no benefit which arises on grant and unlike in Abbot and Philbin there is no “money’s worth”, see ERSM110010 and ERSM110015.
ITEPA 2003 was amended by Finance Act 2016 to treat all share awards on the same basis for the income tax charge. But, for the purpose of S1288, the underlying principle arising from the Abbott and Philbin case is still relevant.
No benefit or liability under Parts 2-7 (Income Tax Earnings and Pensions) Act 2003 arise on the grant of an RSU or LTIP and the liability and benefit only arise when the award vests and the shares are acquired. So, S1288 can apply to the share-based payment expenses arising in respect of this type of option.
This means deductions denied for SBPs recognised in periods which ended more than 9 months before the option was exercised, which have since become deductible because of the application of S1038A(7), can be taken in the period the option was exercised.
Whether an option is a legal option or not will be a matter of fact.