Calculator and pen Home | Selling shares bought under employee option? Tax may be more than you think

Selling shares bought under employee option? Tax may be more than you think

18 June 2009

If you sell shares bought before 10 April 2003 through employee share options - or you have recently sold such shares - your tax liability may have increased.

Previous position

In early 2003 HM Revenue & Customs (HMRC) issued some welcome, although rather unexpected, guidance stating that where an employee exercised either unapproved or enterprise management incentive (EMI) options, his base cost (i.e. the figure deducted from the amount received on sale to determine what amount tax is payable on) was:

This resulted in certain situations where the employee could count the same figure twice, resulting in a higher base cost and therefore a lower gain chargeable to capital gains tax.

Example 1

Bill, an employee previously granted 10,000 unapproved share options, exercised his options on 1 March 2003, paying an exercise price of £5 per share.

At the time of exercise the market value was in fact £10 per share. Bill, unlike many people who acquire shares under unapproved options, did not need to sell his shares immediately to pay his income tax and National Insurance bill, so kept them, and sold them in June 2006, when the market value was £20 per share.

Bill's base cost per share was £10 - the market value of the shares on the date the options were exercised - plus £5 - the amount on which he paid income tax when he exercised his options.

This gave him a total base cost of £15 per share, and with proceeds of £20 per share he was left with a chargeable gain of just £5 per share, meaning he only had to pay capital gains tax on a gain of £50,000.

This shows that HMRC's guidance gave a very favourable outcome, so the Government quickly reversed the treatment for options exercised post-10 April 2003. But the position for options exercised pre-10 April 2003 remained the same, so individuals who had exercised options pre-10 April 2003 could still take advantage of this double credit when they sold their shares.

New position

HMRC has now stated that its previous guidance for options exercised before 10 April 2003 was wrong, although it has not released the legal advice supporting this.

Its revised guidance states that the base cost is solely the market value of the shares at the date the options were exercised. Whilst this may be a more logical position, it can leave individuals with a greater than expected tax bill, the example below reveals:

Example 2

Bill's brother, Bob, was also an employee granted 10,000 unapproved share options, and he also exercised his options on 1 March 2003, paying an exercise price of £5 per share.

Bob decided not to sell his shares, and now wants to sell them in July 2009. Remarkably, given the economic turmoil since Bill sold his shares, the market value of the company's shares is still £20 per share.

However Bob's base cost would purely be the market value of the company's shares at the time the options were exercised, i.e. £10 per share. With proceeds of £20 per share, Bob is left with a chargeable gain of £10 per share, meaning he has to pay capital gains tax on a gain of £100,000, twice the figure Bill had to pay tax on.

A further twist

This change is not just relevant to those who still hold shares.

It also applies retrospectively to those who have sold their shares, but have not yet made their tax returns for the year in which the sale took place, or have submitted the appropriate returns, but the time limits within which HMRC can make an amendment or enquiry have not yet expired.

However, tax returns that fall outside these requirements will not be challenged.

© Shoosmiths. This page is for general information: it is not legal advice. Please read our full terms and conditions for details of the disclaimers and exclusions which apply.

Are any of the issues in this article giving you a headache? If so, we want to know

Name *

Comments*

The information you provide here will be used solely for the purposes of responding to your query for more information see our privacy policy.
 

Get in touch

Tom Wilde

Solicitor
T: 03700 86 8713
I: +44 (0)118 965 8713
E: tom.wilde@shoosmiths.co.uk