ERSM110020 - Securities Options

What are securities options – cash alternative to securities

Phantom options with cash receipt

A phantom option only gives a notional right to acquire shares. On exercise the employee will receive a cash bonus equivalent to the difference between the current share price and the share price at the date of grant. There is no right to receive actual shares.

Subject to the detailed documentation, a phantom option is an option and is therefore excluded from the definition of security. And as there is no right to receive securities neither is it within Chapter 5 Part 7 of ITEPA. Therefore, although a phantom option is an option, it is not a security option. Receipt of the cash will therefore be taxed in the same way as any other cash bonus.

Employer substitutes cash in place of securities

In some cases an option will have an exercise date when securities may be acquired, but the employer reserves the right to pay the cash equivalent instead. As an option it is specifically excluded from the definition of "security" in ITEPA03/S420 (5)(e). But if there is no right to receive securities it is not within Chapter 5 Part 7 of ITEPA (i.e. not a securities option). Receipt of the cash will therefore be taxed in the same way as any other cash bonus. Where the employer chooses to pay the bonus in securities this will be taxed as money's worth in accordance with ITEPA03/S62.

However, if there were a legal right to receive securities, albeit a right that might be lost on the payment of compensation, then the receipt either of the cash or the receipt of the shares would both be taxed under Chapter 5 Part 7 of ITEPA.

However, evidence has been seen that indicates that some companies might be putting in a cash alternative solely to ensure that the options fall outside Chapter 5, with the result that for employees whose earnings were taxable under sections 15 or 21 (Case I Schedule E) but who became non resident before exercise we would lose the Chapter 5 charge.

HMRC does not accept that this works. The employees are being given both an option to acquire shares, and a contract for differences. This means that employees with earnings taxable under sections 15 or 21 (Case I Schedule E) at grant stay within Chapter 5 on the option, but would also be taxed on the market value of the contract for differences up-front. This is clearly not an attractive proposition, and it makes a cash alternative unattractive.

For the other employees, the position is not very satisfactory. HMRC generally seeks a charge to tax when value is received – and for cash LTIPs that is what happens. In practice we are happy for such schemes to be treated in this way for employees with taxable earnings other than under sections 15 or 21 at the time of grant – where the award will be taxed on exercise (subject to the employee still being within the charge to UK tax at that time). This is not entirely satisfactory, but reflects the fact that there are different rules at present based on the residence status of the employee.

Employee substitutes cash in place of securities

In some case the option gives a right to receive securities but the employee can choose to have the value paid in cash. As there is a right to receive securities, it will fall within the provisions of Chapter 5 Part 7 of ITEPA. Receipt will be chargeable as the acquisition of securities pursuant to the employment-related securities option and taxed accordingly. Alternatively receipt of cash will be the receipt of a benefit in money or money's worth in connection with the employment-related securities option and chargeable under ITEPA03/S477 (3)(c).