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Wednesday, 17th April 2024
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Share options - yet again! Back  
Each year the Finance Minister labours over tax proposals on share options. Each year he gets no closer to a satisfactory tax system. This year’s measures in the area of share options represent a low point to date in terms of complexity and meanness.
Back to Basics
The taxation of share options is a running sore. In almost every Finance Bill for the last several years, there has been tinkering with the law in the area. The result has not been to make the tax code any more satisfactory. How did we get into this mess?

Once upon a time income tax was charged on income from employments. Capital gains tax was charged on gains realised by investors. There was no confusion, and no problem. An employee receiving a share option was liable to income tax on the value of the share option when he got it. Thereafter he was treated as holding an investment asset within the capital gains tax code.
This situation, which corresponded to economic reality, was thrown out as long ago as 1986. Under what is now s128 of the Taxes Consolidation Act 1997, a taxpayer is no longer taxed on the value of a share option when he gets it. He is instead charged to income tax on the difference between the value of a share on exercise of the option, and the sum paid for the share. The consequence is to move, potentially, a large part of a capital gain into the income tax net. From that point onwards, there have been problems.

We have seen the introduction of approved share option schemes in the Finance Act 2001. These reversed the treatment outlined above for unapproved share options. It charges the entire ‘gain’ up to the point where an option is exercised, to capital gains tax rather than to income tax, where the section applies. The scheme is hedged round with so many conditions, in particular regarding the similar treatment of all employees, that the scheme has been of little interest.

A second piece of first-aid applied to the share option area was the introduction of s128A. This section permitted a person liable to tax on exercise of an unapproved share option to defer payment of the tax for up to seven years, or until he disposes the share acquired on foot of the option, if earlier. In many cases it enabled an employee who had acquired shares on the exercise of an option to be able to finance the holding of those shares for a period of time. Where tax had to be paid immediately on exercise, many employees found they could not afford to keep the shares they had just obtained.

Thus far we have what is now a common feature of the Irish tax scene, ie we start by amending our tax law in a silly manner, and then follow up with an attempt to undo the effects of the first change, by introducing a scheme of relief whose terms make it unlikely to be adopted widely. The Taxes Acts get larger, and nothing is achieved. What we rarely do is go back and look at the error originally made, and consider undoing it.

Finance Act 2003 – all change.
Finance Act 2003 addressed the problem of ‘underwater options’. Some people had incurred a tax liability on the exercise of an option and found sometime later that the value of the shares they had obtained on exercise was now less than the tax liability. These employees have been charged to income tax on what to a large degree was a capital gain. They subsequently suffered a capital loss. However because the capital loss (on the fall in value of the share acquired) was not within the income tax net, it could not be relieved against income tax, notwithstanding the fact that there had been a substantial earlier income tax charge on a capital gain on exercising the option.

Any reasonable person might have concluded that the simple solution, which would not have cost the exchequer any great amount of money, would have been to grant an income tax relief for the capital loss, paralleling the fact that a capital gain had already been charged to income tax on an earlier stage of the same transaction. God knows why this was not done. It would not amount to seeking a relief for share speculators at the expense of the general body of taxpayers. Rather it would be recognising that the gain taxed on the exercise of the option was an illusory gain which the taxpayer never in fact enjoyed.

This was not how the Minister proceeded. Instead one of the most complex and mean minded reliefs ever conceived of has been introduced. The taxpayer who has incurred a tax liability on the exercise of an employment related share option, and finds that the shares so acquired are worth less than the tax liability is required to discharge the tax liability up to the full value of the shares, whether or not disposed of. Any balance of liability is deferred until such time as the individual realises capital gains on the disposal of other shares (having nothing to do with the options or his employment). He must then continue to make payments against the deferred tax liability in the amount of the after tax gains arising on those shares. This can hang over him for the rest of his life.

Sting in Tail
Having delivered this minor relief, a substantial quid pro quo is required of option holders. Section 128A, which allowed for a deferral of payment of the tax arising on the exercise of a share option, has been repealed and the tax liability payment date has actually been accelerated ahead of any other income tax liability payment date.

A person exercising an employment related share option must now calculate his gain and make a payment of tax at the top marginal tax rate of 42p.c., within 30 days of exercising the gain. In many instances this would be several months (in some cases over a year) before other income tax liabilities for the same year have to be discharged. In other words, a person who exercises an option is penalised as compared to any other taxpayer.

The legislation to give effect to the relief, and to the penalisation by accelerating the payment date, runs to a number of pages of the Finance Bill. It is truly complex stuff with the treatment varying depending on whether an option is exercised before 6 February 2003, before the passing of the Finance Act, before 1 June 2003, or before 30 June 2003. The legislation has certainly ensured that few taxpayers would be able to comply with their tax obligations in the area of share options without engaging the services of a professional tax adviser.

An individual who exercises two share options in a year, and disposes of two other assets in a year may face up to six tax payments in the year. This makes nonsense of a self-assessment system. The Minister rightly prides himself on his rationalisation and simplification of areas of the tax code. The provisions in relation to share options are unlikely to add to his sense of pride.

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