This article explains what tax is liable for individual and corporate option holders in different circumstances
There are 4 key variables for the option holder, that will affect their tax liability.
- A UK tax resident employee, director or non-executive director (NED) is granted options
- A UK tax resident who is not an employee, director or NED is granted options
- A UK based limited company is granted options
- A non-UK tax resident or corporation is granted options
1. When an employee, director or NED is granted an option, there is initially no tax due regardless of the strike price. However, a tax liability is created when they exercise their option.
In cases where shares can be sold immediately, both income tax and NI are due on the difference between the exercise price and the realisable sale price. This must be paid by the company via PAYE and then reimbursed by the shareholder back to the company within 90 days.
In cases where there is no open market for the shares and they cannot be sold immediately, the option holder has a choice whether to pay income tax at that point based on the Actual Market Value (AMV) or Unrestricted Market Value (UMV).
If they choose the likely higher, UMV, they will have a higher income tax bill at the point of exercise, based on the difference between the exercise price and the UMV. But all the upside to point of sale will only be subject to Capital Gains Tax. In this instance, they must complete an ITEPA S431 election within 14 days to ensure that no further income tax is liable.
If they choose to be tax assessed on the AMV, they may have a lower income tax bill at the point of exercise, based on the difference between the exercise price and the AMV. But on eventual sale, the differential that has been saved will be applied to further gains, meaning they could be exposed to both income and Capital Gains Tax.
2. When a UK tax resident who is not an employee, director or NED is granted an option, it is assumed they are being granted this option in return for services rendered. If the exercise price is set below market value at the date of grant, VAT will therefore be due on the difference. The ‘contractor’ should issue the option grantor an invoice, assigning a monetary value to their services plus VAT, who will then pay it in the usual way. Upon exercise of the option the ‘contractor’ will also face an income tax bill, assuming the market value of their shares is now higher than the exercise price.
3. When a UK limited company is granted an option with an exercise price below market value at the point of grant, VAT is due on the difference, as it is assumed the option is being granted in return for services rendered.The ‘contractor’ should issue the option grantor an invoice, assigning a monetary value to their services plus VAT, who will then pay it in the usual way. No tax is due on the exercise of the option as this is deemed the realisation of an asset. However, corporation tax is due on the sale of the shares.
4. When a non-UK tax resident or corporation is granted an option in a UK company they will be taxed in their local jurisdiction and should seek advice accordingly.
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