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HMRC internal manual

Employment Income Manual

PAYE: special type of income: gains from share options: exercise of an option in an unapproved share option scheme: example

On 21 April 2001 an employer granted an employee an option over 2,000 shares in the company’s unapproved share scheme at £1 per share. The employer is a private company, not listed on any exchange. The option can be exercised between 1 January 2003 and 31 December 2007.

On 20 June 2003 the share value reaches £5, the employee exercises the option and acquires 2,000 shares worth £10,000. The shares cannot be sold immediately, but each year on 30 June the employer organises a share sale, at which the company repurchases at market value any shares that employees wish to sell.

Is the employer required to operate PAYE?

Under Section 477 ITEPA 2003, the amount chargeable to tax as employment income is £8,000 (representing the value of the shares acquired when the option is exercised less the amount paid to exercise the option). There was no income tax charge at time of grant because the option could not be exercised more than 10 years later (see Share Schemes Manual, SSM3.3).

The shares are in an unlisted company so none of the definitions of readily convertible asset in Section 710(1)(a) or (b) ITEPA 2003 apply (see EIM11901 to EIM11907). But when the employee acquires the shares on 20 June 2003 he knows that on 30 June it is likely the employer will buy them back at market value.

This constitutes an understanding that trading arrangements are likely to come into existence and, by virtue of Section 702(1)(c) (see EIM11908), the shares are readily convertible assets. Consequently, Section 700 ITEPA 2003 applies and the employer must operate PAYE on £8,000 at the time the option is exercised.