This article explains how tax is liable depending on the circumstances of the holder and the company
There are 4 key variables for the option holder, that will affect their tax liability.
- A UK Tax Resident Employee or Director or Non-Executive Directors
- A UK Tax Resident but NOT an Employee, Director or Non-Executive Director
- A UK Based Limited Company
- Non-UK Tax resident or corporation
In summary, please see the table below.
For more detail on each option holder and their tax liability, please see below.
- IF YOU ARE A UK TAX RESIDENT EMPLOYEE, DIRECTOR OR NON EXECUTIVE DIRECTOR with the company that granted you the options at the point of exercise
IF YOU ARE A UK TAX RESIDENT NON EXECUTIVE DIRECTOR
A NED is treated as an employee by HMRC (as they are an officer of the company) and therefore need to be paid through payroll, with NI. As a consequence, they benefit from the ERS carve out that allows them not to pay any tax on the grant of options that have an exercise price below AMV, so long as they are exercisable within 10 years.
As an Employee, Director or NED there is no tax liability on grant of an option.
Exercising your options when still an employee, and the shares are not immediately able to be sold
You have a choice as to whether to pay income tax at that point based on the AMV (Actual Market Value) of the shares or the UMV (Unrestricted Market Value).
- If you choose the, likely higher, UMV then you will have a higher income tax bill now, based on the delta 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, you must complete an ITEPA S431 election within 14 days to ensure that no further income tax is liable.
- If you choose to be tax assessed on the AMV, however, you may have a lower income tax bill now, based on the difference between the exercise price and the AMV, but on eventual sale, the differential that you have saved now will be applied to further gains such that they will partly be exposed to both income and capital gains tax.
Exercising your options when still an employee and the shares can be immediately sold
In this circumstance, both income tax and NI are due to 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.
2. IF AS A UK TAX RESIDENT YOU ARE NO LONGER AN EMPLOYEE with the company that granted you the options at the point of the exercise, OR NEVER HAVE BEEN
Under these circumstances, you are no longer caught by the employee-related benefits tax legislation.
You must therefore pay income tax in your annual tax return based on the difference between the exercise price and the Market Value (MV) of the shares at the time. At the eventual sale, capital gains tax will be due on any further gains from that point.
In addition, if you were not an employee at the date of grant, you may have tax exposure on the award of the Option, to the extent that the exercise price is below the Market Value of the shares at that point. This is typically a VAT exposure on this amount.
3. IF YOU ARE A UK LIMITED COMPANY
As an Ltd., there is a tax liability on grant of an option, if the grant price is below MV.
Tax on grants depends on whether the exercise price is above or below the market value. If above, there is no tax liability at grant. If issued with an exercise price below MV then that incurs a VAT liability.
At exercise, unapproved options do not incur any tax liability at this point, as it is the realisation of an asset. Corporation tax is then due on the sale of the shares.
For corporate tax purposes, the acquisition of the option or warrant is the tax point for the company and should be recognized in sales at market value received for services supplied or to be supplied. This will be a VAT supply and needs to be covered by the issue of an invoice. The sale of the share will give rise to a capital gain subject to corporation tax and the individual will have to decide how to access the net cash receipt (bonus or dividend or liquidation receipt).
4. IF YOU ARE NON-UK TAX RESIDENT
Under these circumstances, it is important that you understand what the relevant local tax treatment for options is, whether there is a tax liability at grant, exercise and sale of the option.