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HMRC internal manual

International Manual

HM Revenue & Customs
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Transfer pricing: Types of transactions: share options: transfer pricing issues: other situations

Cash settled transactions

A share plan may provide for employees or the Provider to choose to settle the transaction with cash payment instead of actual shares, or may only provide for cash payments to be made (eg “phantoms” calculated on the basis of the increase in share price).

In all such cases the facility provided is essentially of the same value to the Employer as if employees received shares, so for the purposes of transfer-pricing the value of the facility provided by the Provider to the Employer should be the same.

So the same methods as outlined earlier above should be used to calculate the value of the facility in all these cases, even if awards can be settled in cash, or have to be settled in cash.

While for transfer pricing purposes the actual or imputed “arm’s length” payment from the Employer to the Provider should be the same whether the instrument is settled in shares or cash, the tax consequences could be different.

Typically, an imputed or actual receipt of the fair value amount will still be a capital receipt for the Provider that does not give rise to taxable income, as the company is providing the instruments other than in the context of trading in the instruments. (The arbitrage provisions in FA(No.2)2005/S26 could be relevant if the Employer obtains a deduction for the payment.)

For the Employer, the implications of FA03/SCH23 may be different - Schedule 23 is not relevant to “phantoms” (cash payments only), for example. If Schedule 23 does not apply then, other provisions governing deductions for employee remuneration costs, such as CTA09/S1290, may need to be considered.

Options not vesting

Where share options are provided by one group company to employees of another and these options do not vest (eg because of the outcome of non-market vesting conditions), some subsequent tax adjustment may be necessary.

At arm’s length the terms of the transaction between the Employer and the Provider could be expected to make some provision for circumstances where options do not vest (perhaps in the form of some kind repayment back to the Employer). However, if the employer has made no deduction for any payment to the Provider for the options (eg because FA03/SCH 23 was expected to apply), and any such payment has not given rise to taxable income for the Provider (because it had to be accounted for in reserves), then the position can just be left as it is. Only if one party would obtain a tax advantage without any repayment being made (eg because they have obtained a deduction for payment for the options) would it be necessary to consider what repayment could have been expected at arm’s length (eg perhaps based on the value of the options at the tie when it is established that they will not vest).

Treatment of part of payment as distribution

In some circumstances, if an intra-group payment is made, accountancy rules may require part or all of it to be accounted for in a different way, for example as a distribution. In these circumstances, normal tax consequences will apply. This guidance does not affect the way other tax rules operate, such as rules relating to distributions. Only if the actual payment was not an arm’s length result and gave rise to a tax advantage would transfer pricing rules come into play. (In particular, if an excess payment was made that results in a tax disadvantage, then this would stand for any disadvantaged party.)

Employee benefit trusts

A parent company may be a settlor of a trust that makes share-based payments to employees of another group member. In assessing the nature, extent and value of the facility provided by the settlor company in such a case, it is important to consider all possible elements, which may include:

  • the establishment of any trust and plan administration (which will typically comprise administration services);
  • provision of share awards; and,
  • any issuing of new shares.

At one extreme, if the Provider is wholly financing the trust’s provision of a share plan to employees of group subsidiaries, then the Provider should receive or impute (under transfer pricing rules) the same receipts as it would if it provided the share plan itself and no trust was involved. In such circumstances, the delivery of the share plan to the Employer by the trust is part of the overall facility. Where the Employer makes some payment direct to the trust, reducing the financing required from the Provider, this would need to be taken into account in pricing the facility.

At the other extreme, the Employer might enter directly into arrangements with the trust that are indistinguishable from the arm’s length arrangements that would exist between the Employer and a completely independent plan administrator delivering a share plan for the Employer. There may be no significant financial or other involvement by the settlor company, beyond establishing the trust. In such a case, the arm’s length pricing of the facility provided to the Employer by the settlor company would need to take account of the limited functions and risks resting with the settlor company.

Even if the Employer sets up its own trust and operates its own share plan, transfer pricing rules will apply if the Employer makes a payment to the trust to enable it to subscribe for newly issued shares in a different group company (as opposed to buying the shares in the open market). This is because a provision would be made between connected parties through a series of transactions - indirectly the Employer would be paying the other group company to supply shares. (Though if the payment by the Employer and the receipt of the other group company cannot affect the tax calculation of either (eg because FA/SCH23 denies a deduction for the employer and there is no income receipt for the other group company), then there may be no tax consequence).

Cost Plus/Transactional Net Margin Methods

Additional guidance is provided at INTM421060 in relation to application of the cost plus methodology.


Gismo PLC has 7 UK subsidiaries. Each operates a share plan of which that of Gismo Sales Ltd is typical. Gismo Sales has 100 employees, all of whom are eligible for inclusion in the group plan that grants 3-year options annually if performance is satisfactory. The options are over shares in Gismo PLC as all subsidiaries are 100% owned and the group wants that to continue. Gismo PLC also administers the group plan for all employees. From 1st January 2005 Gismo Group must account for the cost of providing options to group employees under FRS20/IFRS2. Intra-group, no accounting entries have ever been made.

On 1st January 2005 all 100 employees of Gismo Sales Ltd are granted options over 1000 Gismo Group shares: exercisable in 3 years at the current price of £1. Gismo Group consolidated accounts account for the fair value of options for 80 employees, as in the past only around 80% of options have been exercised in due course. No intra-group charges are made.

The Gismo group is aware that transfer pricing rules apply, but the group establishes that if an intra-group payment were made any amount received by Gismo PLC for share options would have to be accounted for in reserves and would not affect the calculation of taxable profits. So, the group decide that the tax computation of Gismo PLC should just include a taxable adjustment based on the value of the administrative services provided by Gismo PLC in relation to the participation of Gismo Sales Ltd employees in the group share plan. This transfer pricing adjustment is calculated either by finding a comparable uncontrolled price, or using a cost plus method.

Allowable deductions for Gismo PLC are the costs of providing the administrative services. Following FA03/SCH23 no group company claims anything for the cost of providing shares, as this will be claimed in the year of exercise by the employing company, Gismo Sales Ltd.

Gismo Sales Ltd claims a compensating adjustment to make an allowable deduction for the value of the administrative services, calculated on the same basis as the transfer pricing adjustment made by Gismo PLC. No adjustment is needed in their tax computation in 2005, 2006 and 2007 for the cost of providing shares as the deduction is governed by FA03/SCH23. So in their 2008 tax computation they will expect to claim a statutory deduction under Schedule 23 for those options that are exercised by their employees. This deduction will match the spread that will be chargeable on their employees, i.e. the difference between the market value when options are exercised and the cost of these under the option, £1 x 1000.