At a time when shares are quoted at around £5 an employee wishes to exercise an option to acquire shares in the quoted employing company at an exercise price of, say, £1. The employee agrees with the employer, before the option is legally exercised, to what is often referred to as a "cashless exercise", so that at the point of exercise either:
There can be difficulties in establishing the market value for the purposes of calculating the gain on exercise, because the broker may sell the shares in various tranches during the day so as not to flood the market. Prices fluctuate during the day and the price or prices obtained may not equal the “quarter-up” figure as required by TCGA92/S272. For further details on “quarter-up”, see CG59511 and CG59512.
Normally the market value of listed shares, i.e. the amount those shares might reasonably be expected to fetch on a sale in the open market, is arrived at using the prices in The Stock Exchange Daily Official List, which is prepared at the end of each day's trading. However, where the employer and employee have entered into a contract, arrangement or agreement (the cashless exercise) prior to the exercise of the option, as a result of which the employee is obliged to sell at least the number of shares required to fund the exercise price and/or the PAYE/NIC liabilities immediately after exercise, then it is possible to ascertain a precise figure for the market value of the shares acquired.
Provided the sale is in the open market, the market value per share of all the shares acquired on the exercise of the option that are covered by the cashless exercise contract, arrangement or agreement is equal to the sale price per share for the purposes of computing the option gain under ITEPA03/S477. This is the case for the shares acquired and immediately sold and for any shares retained as part of the cashless exercise.
However, where the purpose, or one of the purposes, of a contract, arrangement or agreement, which purports to be a cashless exercise, is the avoidance of tax and/or NIC then the market value of the share(s) sold may not provide an accurate measure of the amount which the shares acquired "might reasonably be expected to fetch on a sale in the open market" and the price given by the Official List will be appropriate.
