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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Options: market value rule: examples: employment-related share options

Example 1: Approved share option scheme

A share option is granted to an employee in consideration of services in the employment at a time when the shares are worth only £1 per share. No specific consideration, other than the services, is given by the employee for the option. The option entitles the employee to acquire 1,000 shares at £2 per share from a UK resident Employee Benefit Trust. Five years later the employee exercises the option, pays £2,000 and acquires 1,000 shares which, at the time he acquires them, have a market value of £5,000 (£5 per share).

The option is granted under an approved company share option plan, and all the conditions for approval are met. There is no liability to Income Tax in respect of either the grant of the option or its exercise.

There are special provisions in TCGA92/SCH7D, see CG56425+, and TCGA92/S149A, see CG56415+, that prevent the application of the market value rule to the grant or exercise of approved share options.

Employee Benefit Trust’s share disposal proceeds

Exercise on or after 10 April   Exercise before 10 April  
       
2003   2003  
Received for option Nil Received for option Nil
Received for shares £2,000 Received for shares £2,000
Disposal proceeds £2,000 Disposal proceeds £2,000

Employee’s share acquisition costs

Exercise on or after 10 April   Exercise before 10 April  
       
2003   2003  
Amount charged to Income Tax Nil Amount charged to Income Tax Nil
Paid for option Nil Paid for option Nil
Paid for shares £2,000 Paid for shares £2,000
Acquisition cost £2,000 Acquisition cost £2,000

Example 2: Unapproved share option scheme

As in example 1 a share option is granted to an employee in consideration of services in the employment at a time when the shares are worth only £1 per share. No specific consideration, other than the services, is given by the employee for the option. The option entitles the employee to acquire 1,000 shares at £2 per share from a UK resident Employee Benefit Trust. Five years later the employee exercises the option, pays £2,000 and acquires 1,000 shares which, at the time he acquires them, have a market value of £5,000 (£5 per share.)

The option is an unapproved share option, an Enterprise Management Incentives (EMI) option, or an approved share option on whose exercise an amount counts as employment income (this may happen, for example, if an employee exercises an option early).

  • When the option is exercised the employee will be chargeable to income tax in respect of an amount which counts as employment income. The taxable amount is the difference between the market value of the shares when he acquires them less the consideration he gives (£5,000 less £2,000) and less the amount he gave for the option (nil). The amount counting as employment income is thus £3,000. See ERSM110510.
  • The grant of the option is by reason of the employment, but there are special rules in TCGA92/S149A, see CG56373+, that prevent the substitution of the market value of the option for the amount actually given for the option.
  • The acquisition of the shares when the option is exercised is by reason of the employment and the market value rule is capable of applying. However, for options exercised on or after 10 April 2003 TCGA92/S144ZA applies so that the actual consideration given is used in the computations. In determining the employee’s acquisition cost for the shares there may be added to this actual consideration the £3,000 counting as employment income on exercising the option - see CG56321A. Where the option was exercised before 10 April 2003, following the decision in Mansworth v Jelley, the market value of the shares at the time they passed to the employee is substituted for the consideration actually given, and no account is taken of the amounts given or received for the option.

Employee Benefit Trust’s share disposal proceeds

Exercise on or after 10 April   Exercise before 10 April 2003  
       
2003      
Received for option Nil    
Received for shares £2,000 Market value of shares £5,000
Disposal proceeds £2,000 Disposal proceeds £5,000

Employee’s share acquisition costs

Exercise on or after 10 April   Exercise before 10 April 2003  
       
2003      
Employment income £3,000    
Paid for option Nil    
Paid for shares £2,000 Market value of shares £5,000
Acquisition costs £5,000 Acquisition costs £5,000

If the shares are provided by the company (the employer) issuing new shares directly to the employee, no chargeable gain will accrue to the company because the issuing of shares is not a disposal. The employee’s position remains as shown.