Interaction with Double Taxation Agreements: Examples
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.
Mr. A is resident and ordinarily resident in the UK and working here on 1st January 1997. On that day he is granted an option to purchase 1,000 shares in the companyin four years’ time at the 1/1/97 market price of £1. On 1st January 2001 he is moved to another country and is still in the employment there when the option is exercised on 1st 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 = £4,000. The charge falls to Schedule E generally [SectionI35(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 36 of September 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 informationon periods of employment spent abroad they may be able to operate PAYE for the non-resident employee only on the UK proportion.
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 ofthe option. The total gain in value of £4,000 is apportioned 75% to the UK and 25% to theother country.
Mr. B is resident and ordinarily resident in the UK and working here on 1st December 1996 when he is granted a share option. He works overseas during 1997. He returnsto the UK on 1st January 1998 and is still in the employment here when he exercises the option on 1st 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 allow credit for this against the Section 135 charge.
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 theshares.
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 outin the other country during the period between grant and exercise of the option and double taxation has occurred. Whilst the UK will tax the whole gain in value credit may beallowed if foreign tax has been paid in respect of that period. Refer such a claim to Employment Income Technical.
C may 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-domiciliaries at Section 12,TCGA 1992 [see CG 25300].
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 UKand 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 ofselling 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 foreign tax charge. 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. Refer such cases to Employment Income Technical.
- 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.
Where a taxpayer within example 5 makes a claim for relief under a DTA it should be referred to Employment Income Technical, before any comment is made outside the text of Tax Bulletin 55.