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It's Official - Extracts from the Revenue's 55th Tax Bulletin.

17 October 2001
Issue: 3829 / Categories:

Share options

This article is concerned only with options granted under an unapproved share option plan and non-qualifying exercises of options granted under an Inland Revenue approved plan. A 'non-qualifying' exercise here means one where the conditions for income tax relief have not been followed, such that there is an income tax charge.

To avoid double taxation, where an employee:

Share options

This article is concerned only with options granted under an unapproved share option plan and non-qualifying exercises of options granted under an Inland Revenue approved plan. A 'non-qualifying' exercise here means one where the conditions for income tax relief have not been followed, such that there is an income tax charge.

To avoid double taxation, where an employee:

* was granted a share option in the United Kingdom during the course of an employment;

* exercised that employment in the other country during the period between the grant and exercise of it;

* remains in that employment at the date of the exercise; and,

* would be taxed by both of them in respect of the option gain; and

* is not resident in the United Kingdom at the date of exercise;

then the United Kingdom will give relief in calculating the tax charge for the proportion of the option gain which relates to the period or periods between the grant and exercise of the option during which the employee exercised the employment in the other country.

The gain will normally be time-apportioned on a straight-line basis. Periods not in that particular employment are left out of account so that the apportionment is still made on the basis of relative periods of employment in each country. Very occasionally this may not provide a sufficiently accurate apportionment. If so, another method may be used provided this does not produce double taxation or lead to income going untaxed in either country. In other cases credit relief may be appropriate.

In the following examples, all the share option plans are unapproved, and there is a comprehensive double taxation agreement with the overseas country containing a provision along the lines of Article 15 of the Organisation for Economic Co-operation and Development model.

Example 1

Mr A is resident and ordinarily resident in the United Kingdom and working here on 1 January 1997. On that day he is granted an option to purchase 1,000 shares in the company in four years' time at the 1 January 1997 market price of £1. On 1 January 2001 he is moved to another country and is still in the employment there when the option is exercised on 1 January 2002. At that date the shares are worth £5 each.

A is resident and ordinarily resident in the United Kingdom at the date of grant and is therefore liable to income tax under section 135 on any gain realised at exercise.

In this case the gain is 1,000 x £4 = £4,000. The charge falls to Schedule E generally (section 135(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 United Kingdom for four years and in the other country for one year. 80 per cent of the gain (£3,200) will therefore be assessed in the United Kingdom, and 20 per cent (£800) will be regarded as attributable to the other country.

The exercise of the option will be within the scope of pay-as-you-earn by virtue of section 203FB if the shares are readily convertible assets (see Tax Bulletin Issue 36, August 1998).

Example 2

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 of the option. The total gain in value of £4,000 is apportioned 75 per cent to the United Kingdom and 25 per cent to the other country.

Example 3

Mrs C is resident but not ordinarily resident in the United Kingdom when an option is granted. She is still resident here when she exercises the option and sells the shares.

At the time of grant, the United Kingdom 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 United Kingdom 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 United Kingdom at both the date of grant and the date of exercise, the United Kingdom 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 double taxation agreement may be relevant if the duties of the employment have been carried out in the other country during the period between grant and exercise of the option and double taxation has occurred. C may, however, be liable to capital gains tax on any gain she makes on selling the shares.

Example 4

Mrs D is not resident and not ordinarily resident in the United Kingdom when her employer grants her an option to purchase shares. She moves to the United Kingdom and performs the duties of the employment there. She exercises the option when working in the United Kingdom and sells the shares.

D will not be liable to United Kingdom income tax on any gain realised at exercise, unless the grant of the option is clearly related to duties performed in the United Kingdom.

She may, however, be liable to United Kingdom capital gains tax on any gain realised as a result of selling the shares acquired.

Strictly, the United Kingdom is not obliged to allow a foreign tax credit for any foreign tax paid on exercise against any United Kingdom capital gains tax payable on disposal. Nevertheless, where tax has been paid in a treaty partner country, the Revenue 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 will allow a proportion of the foreign tax paid as a credit against United Kingdom 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.

Issue: 3829 / Categories:
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