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Tuesday, 16th April 2024
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A look at share options again Back  
The taxation of share options was the hot topic prior to Budget 2001. The Finance Act delivered a proposal (approved share option schemes) that meets no objective other than that of appearing to do something. The taxation of share options should be reviewed from scratch.
What problem?
When we speak of the problems relating to the taxation of share options, what do we mean? Why should a share option present tax problems where cash payments do not?

The answer is that a different tax system applies to the provision to an employee or director of a share option than applies to the payment to him of cash. When an employee/director is paid cash, taxation depends on the answer to a simple question – ‘Is it income from your employment?’ If it is employment income, then it is subject to income tax. If it is not employment income, then ultimately it is not subject to income tax.

Simple principle
This simple principle applies in almost every situation other than share options. When an employer hands over ownership of a motor car, or a painting, or a house to an employee as a reward for his services, the value of what the employee receives is regarded as employment income and it is taxed on receipt. And that is the end of the matter.

If years after he has received the asset the employee sells it at a profit, he will be charged to capital gains tax, but he will not be charged to further income tax as if the gain on selling the asset years later was employment income. And if he rents out the asset after receiving it, the rental income is not regarded as his employment income. The connection between the employment and the asset is broken once the employer parts with it to the employee.

That is a simple and logical system. Other than involving the pain of paying taxes (as inevitable as death) it is unobjectionable.

1986 blunder
Since 1986 matters have been quite different in the area of share options. S128 of the Taxes Consolidation Act provides for special treatment for a share option. Instead of the employee being taxed on the value of the share option when the employer provides it to him as a reward for services, the employee is instead taxed on the value he manages to extract from the option subsequently. That might be from selling the option, or being paid not to exercise it, or by exercising it and obtaining a share for less than its then market value.

Notwithstanding that the option has ceased to have any connection with the employment once it is handed over to the employee, the Taxes Acts artificially creates a deemed continuing connection between the option in the ownership of the employee, and his employment (even after the employment it has ceased!). It is from this special artificial treatment that all of the resentment and difficulties that the tax treatment of share options creates, has its origins.

Back to basics
Rather than attempting to patch up the system with approved share option schemes and the like, it might be better to go back and question why we have the problem in the first place. Why are share options treated differently to any other form of asset provided to an employee by his employer?

Consider the position where an employer pays wages of ?1,000 to an employee, and the employee, having paid tax of say ?300 on that receipt, uses the balance of ?700 to purchase an option from the company to subscribe for shares. If that option is obtained by him as an investor, and not as an employee, what he subsequently does with the option is a matter for capital gains tax. If he exercises the option and acquires shares subsequently, there will be no immediate capital gains tax charge. No charge will arise unless he sells the shares at a gain and then a capital gains tax charge (not an income tax charge) will arise.

If however the employer, instead of paying the wages above, paid to the employee a share option worth ?700 a different treatment is applied. The subsequent exercise of that share option at a time when the share price has increased over the option price would give rise to an income tax charge (possibly deferred). The contrasting treatment does not make much sense. Indeed it is clear that the tax treatment where a share option is granted directly (rather than purchased as an investor) is penal. Why should an employee be penalised for taking his remuneration in the form of a share option rather than in the form of cash? The only answer which occurs is that those who primarily influence the design of the tax system do not tend to have much personal opportunity to be remunerated in the form of share options rather than in the form of money. Persons in that situation may regard share options with some degree of envy, since we tend to hear only of the options which work out well. The recent dotcom fiasco is a reminder that the value of options can fall as well as rise!

Share options matter
Share options are important to a company as being a means of remunerating directors and employee without a direct cash cost. It seems odd that the tax system should be biased against such an approach. Surely at the least one should expect a neutral tax treatment?

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