| What are my options? |
Back |
| The rules in the Finance Act 2003 which altered the tax treatment of options are complex. Different regimes have application depending on when options are exercised, and when certain elections are made. |
There are three tax treatments of an employment related unapproved share option which are less penal than what might otherwise apply.
• An election may be made to defer the payment of tax that arises on the exercise of an employment related share option until the date of disposal of the share acquired, or seven years after exercise, whichever is the earlier.
• An election may be made to defer potentially indefinitely, the payment of tax arising on the exercise of an employment related share option where the value of the share acquired is less than the tax liability at certain dates.
• The payment date for tax arising in relation to the exercise of a share option may be the normal date for payment of preliminary tax of the individual, rather than the new penal system which requires payment within 30 days of exercise.
For those who have share options, whether recently exercised, or unexercised, the focus must be on determining which of these treatments they may be eligible for, and which of those that are available to them is the most advantageous.
Payment deferral
The right to elect to defer payment of tax arising on exercise until the shares are disposed of, or seven years, whichever is the earlier, applies only to options exercised before the Finance Act 2003 became law. The Act became law on signature by the President on 28 March 2003. The right to elect therefore is confined to options exercised up to and including 27 March 2003.
It is not necessary that the election for the deferral should have been made by 27 March. Where the option was exercised in the year 2002, that election may be made at any time up to 31 October 2003. An election may be made at any time up to 31 October 2004 in respect of options exercised in the period 1 January 2003 to 27 March 2003. The election in question has to be made in writing to an Inspector of Taxes. It is not essential that it be made along with the return of income relating to any period, provided it is made within the correct time limits described above.
Underwater option election
An underwater option is one where the shares acquired on the exercise of the option have a market value which less than the outstanding amount of tax payable arising from the exercise of the option. The situation typically arises where the value of a share has collapsed after it was acquired, and before the tax arising on the exercise of the option has been paid.
The relief granted in respect of underwater options (if elected for) will limit the immediate obligation to pay tax on what would otherwise be the due date, to the market value of the shares on that date, and would defer the balance until those shares are subsequently disposed of, and then to the extent of the proceeds of those shares. However a tax payment may also become due to the extent of any capital gain subsequently realised by the taxpayer on the disposal of any other shares, until the total tax liability has been discharged.. The tax liability is effectively forgiven if it is still outstanding at the date of his death.
An underwater election is possible only if made by 1 June 2003. The election can only be made if the option was exercised before 6 February 2003.
An election for ‘underwater treatment’ can be combined with an election for the ‘seven year deferral treatment’. Equally, a person might decide to make only one of those elections.
Where a person has made an election for ‘seven year deferral’ and also makes an underwater election the two set of reliefs interact. Where the election for deferral was made in 2000 or in 2001, the payment dates and amounts will be determined by the seven year deferral rules, and not the underwater option rules. Where the seven year deferral election is made in respect of 2002, or 2003, the payment dates and amounts will be determined by the underwater election rules rather than the seven year deferral rules.
Where the seven year deferral election operated on its own without interaction with an underwater election, tax normally became payable on 31 October in the tax year following the ‘trigger year’ ie the year in which the share was disposed of, or the seventh anniversary as the case may be. Where however the underwater election also has application, that payment date is brought forward to be 30 days after the date of disposal of the shares, or 30 days after the seventh anniversary, as the case may be. The payment date cannot be earlier than 30 June 2003.
Avoiding 30 day payment dates
The Finance Act 2003 has introduced penal tax payment dates in relation to tax on employment related share options. The tax is payable 30 days after the exercise of the share option.
Where the option is exercised before 30 June 2003 then more favourable payment dates may be availed of. Where neither the ‘seven year deferral’ election nor the underwater election have been made, the normal payment dates in relation to tax arising from the exercise of an option prior to 30 June 2003, are for elections in 2002, 31 October 2002 and for elections in the first half of 2003, 31 October 2003.
Because of the rules of self-assessment, many taxpayers will be entitled to base their payment on their prior year liability for preliminary tax in respect of income tax. Those taxpayers who exercise share options and had a nil preliminary tax liability in the prior year effectively get a one-year extension on the payment date for the tax. Thus the effective payment date could be as late as 31 October 2004, for elections in the first half of 2003.
There is no denying that the taxation position of an option holder is akin to a jungle. Not only are there savage bears prowling around the commercial value of his option but there is a thicket of mantraps created by tax law around the taxpayer.
Exercise of a share option (or a decision not to exercise) has implications in a wider way than in relation to payment dates. Any tax liability on deemed income which arises in this area can impact on limits to the relief which is available to a person in respect of pension contributions (whether in an occupational pension scheme relating to an employment, or in a non pensionable employment or self-employment situation). It is therefore wise to take advice on the pension positions before the taxpayer begins to consider his options. |
Ray McKenna is a director in KPMG.
|
| Article appeared in the April 2003 issue.
|
|
|
