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Wednesday, 24th April 2024 |
| After several months of lobbying the Finance Act has delivered a 20 per cent CGT rate for employment related share options. This is hedged around with numerous conditions. The new proposal is a compromise which has left many unhappy. |
The new scheme
Prior to the current Finance Bill proposals an employee who exercised a share option which he obtained by reason of his employment became liable to income tax. It was charged on the difference between the market value of the share on the exercise of the option, and the sum which he had to pay for the share. However he could defer payment of tax upon that deemed income for up to seven years, provided he retained the share for that long.
The Finance Bill has introduced an alternative taxation system. The new system applies to the exercise of an option obtained under an approved share option scheme. Where the new system does not apply by reason of the taxpayer not meeting the conditions attaching to it, the tax continues to operate as before.
Where the grant of a share option falls within the new approved share option scheme, the taxpayer who receives the option is taxed neither on its receipt, nor on its exercise. Instead he is charged to capital gains tax at a rate of 20 per cent on the disposal of the share, and on the difference between what he paid for the share, and what he receives for its sale.
The small print
The new scheme is tightly hedged around with conditions. The scheme must be approved by the Revenue.
The scheme must be open to all employees and directors. However it is permitted to exclude an employee/director until they have had at least three years’ service. Any person holding 15 per cent or more of the share capital may not participate under a scheme set up by a close company.
At least three years must elapse between the grant of the option and the disposal of the share acquired on foot of it, in order that the new scheme may operate.
A potentially limiting and controversial aspect is the requirement that for a major element of the scheme (70 per cent of the options to be granted) all those eligible to participate as defined above must participate on broadly similar terms. Their degree of participation can be varied having regard to length of service, level of salary and similar matters, so total equality is not required.
The scheme can have a second element (accounting for not more than 30 per cent of the options granted in any year). In that second element there is no requirement that those participating should do so on equal terms. There is however an overall requirement in the case of a group scheme (which many schemes will be), that scheme should not have the effect of conferring benefits mainly on directors or higher paid employees. The Act does not define what is meant by higher paid employees.
Although part time directors are eligible to participate in an approved scheme, they may not participate in the second element which permits participation on unequal terms. Part time directors may not be treated as high flyers, it seems.
The new scheme does not address the needs of a company primarily interested in providing options to a few key employees, but without wishing to extend participation across all employees. Even where a company is willing to extend participation, it will find the restrictions described above may prevent it competing on equal terms in the market place for key employees against UK firms, who have a more flexible scheme.
Old options
The new scheme is theoretically open to those holding share options granted before its start-up date (15 February 2001). The holders of options granted prior to that date may benefit from the new treatment if they exercise their options after that date, and if they obtained it under a scheme meeting the requirements of the legislation, and approved by the Revenue before 31 December 2001.
It would be surprising if many schemes under which options were granted prior to 15 February 2001 would be able to meet the requirements of the legislation in every respect. If they do so, it would show extraordinary foresight in those who designed them! Whether or not the holders of existing options can benefit from the new scheme may therefore be a matter of a lottery.
Many multinationals use share option schemes world-wide. Their wish to have a uniform scheme throughout their group may make it difficult to mould the scheme for their Irish subsidiaries to the needs of the legislation. The very detailed nature of the conditions laid down in the legislation will have disappointed the multinationals.
Divisive?
The new share option scheme, despite its ‘open to all’ character has the potential to be divisive. Being linked to the issue of shares in a company, it is most relevant to those who are employed by quoted companies, and of some relevance to those employed in unquoted companies where a market can be created in the shares. But it has no apparent relevance to those employed by the State or by unincorporated businesses, or by very small companies whose shares are inherently unmarketable. This problem had been recognised and the Minister had been lobbied to introduce ‘gain sharing.’
Gain sharing is typically a system of profit sharing, where the employee must defer receiving the profit share or bonus. The Minister has promised to examine this for future Budgets.
The usual rushed parliamentary timetable for a Finance Bill has meant that the Minister finds himself introducing a share option scheme that leaves many sectors unhappy, and does not wholeheartedly address the needs of any sector.
Why share options?
Why should we have a share option scheme? This is a reasonable question. Surely reducing the rate of tax on employment income would be a more straightforward way to go forward if the rate is thought too high?
The answer to this is simple. The taxation of share options is a problem of our own creation. Prior to 1986, where an employee received an option to subscribe for shares, if the option had value (which generally it would if the option price was less than the then market price) the employee was charged to tax as having received a profit from his employment, on the value of the option.
Thereafter his dealings with the option, and any share he acquired under it, were recognised as having nothing to do with his employment, and being within the capital gains tax regime, just as were the dealings of any other person with an option or share.
The present problems have arisen only because since 1986 the State has sought to tax the capital gain arising on the growth in value of a share option, and shares obtained by reason of it, as if they were income arising from an employment, which they are not. Because of that mistaken approach adopted in 1986 we are plagued with these problems.
The 1986 approach defied economic logic. No wonder the Minister finds it so hard (and time consuming!) to undo the damage. The simple answer, to repeal the legislation introduced in 1986, appears to lie beyond political will.
John Bradley is a Director in KPMG. |
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| Article appeared in the March 2001 issue.
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