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HMRC internal manual

Employment Income Manual

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HM Revenue & Customs
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PAYE: special type of income: gains from share options

Section 700 ITEPA 2003

Where an employee is granted a right to acquire shares (an option) under an option plan that is not a scheme approved by HMRC, there will be a potential tax charge under Part 7 Chapter 5 ITEPA 2003 when the option is exercised, assigned or released (see Share Schemes Manual, SSM3.1).

The legislation at Part 7 Chapter 5 ITEPA 2003 was amended by Schedule 22 FA 2003 with effect from 1 September 2003. The guidance below relates to share options exercised before 1 September 2003. For:

  • securities options that are share options exercised on or after 1 September 2003, or
  • securities options that are not share options that are exercised on or after 16 April 2003

see EIM12300.

A charge to tax may also arise when the option is granted, but only if the option is capable of being exercised more than ten years after it was granted (sometimes referred to as “long options”). The employer will then be required to operate PAYE in respect of the grant of the option if the option itself is a readily convertible asset (see EIM11855)

Section 700 ITEPA 2003 says that the employer is required to operate PAYE in the following circumstances:

  • the option was granted on or after 27 November 1996
  • the exercise of the option gives rise to a tax liability under Section 477 ITEPA 2003 and
  • the shares that the employee acquires are readily convertible assets (see EIM11855).

Certain shares are excluded from being assets for the purposes of Part 11 Chapter 4 ITEPA 2003 and so cannot be readily convertible assets (see EIM11931).

Exercise of share options: who is required to operate PAYE?

The person who was the employer at the time the option was granted must operate PAYE when the option is exercised (see examples EIM11877 and EIM11878).

The definitions of employee (see EIM11804) and employer (see EIM11805) for the purposes of Part 11 ITEPA 2003 include ex-employees and hence ex-employers. Thus the person who was the employer at the time the option was granted remains responsible for operating PAYE when the option is exercised even if the option holder is no longer an employee of that person at the time of exercise.

Assignment of share options

Section 700 ITEPA 2003 also requires that PAYE is operated on payments to employees, either in cash or in readily convertible assets, in return for assigning a share option. If the payment or value of the payment made in readily convertible assets exceeds the amount taxable as employment income under Section 477 ITEPA 2003, then PAYE only applies to the amount that is taxable.

PAYE applies to all cash payments, including those in respect of assignment of an option including options over shares in approved schemes and options overshares in unapproved schemes granted before 27 November 1996.

Where an option is assigned in return for cash, the person paying the cash must operate PAYE. Where an option is assigned in return for a readily convertible asset, the person who was the employer at the time the option was granted must operate PAYE.

Release of share options

Section 700 ITEPA 2003 also requires that PAYE is operated on payments to employees, either in cash or in readily convertible assets, in return for giving up or not exercising a share option. These are sometimes known as cancellation or release payments. If the payment or value of the payment made in readily convertible assets exceeds the amount taxable as employment income under Section 477 ITEPA 2003, then PAYE only applies to the amount that is taxable as employment income under Section 477 ITEPA 2003.

PAYE applies to all cash release payments including those paid to employees for not exercising options over shares in approved schemes and those paid to employees for not exercising options over shares in unapproved schemes granted before 27 November 1996 (see example EIM11879).

Where an option is released or cancelled in return for cash, the person paying the cash must operate PAYE. Where an option is released or cancelled in return for a readily convertible asset, the person who was the employer at the time the option was granted must operate PAYE.