SE11853 - PAYE avoidance: gains on share options

Section 203FB ICTA 1988

Gains from share options

From 6 April 1998 Section 203FB introduced new rules for gains made on the exercise of share options and certain payments made to release or surrender share options.

Exercise of share options

Where an employee is granted an option over shares in a scheme not approved by the Inland Revenue, there will be a potential tax charge under Section 135 ICTA 1988 when the option is exercised, assigned or released (see Share Schemes Manual 3.1).

A charge to tax when the option is granted only occurs if the option is capable of being exercised more than ten years after it was granted (seven years for options granted before 6 April 1998) – sometimes termed “long options”.

Section 203FB provides that PAYE should be operated on the exercise of a share option where:

• the option was granted on or after 27 November 1996; and
• the exercise of the option gives rise to a tax liability under Section 135; and
• the shares which the employee acquires are readily convertible assets.
• The person who was the employer at the time the option was granted must operate PAYE when the option is exercised. If the option holder is no longer an employee of that person see SE11920.
• See example SE11860 and example SE11861.

Approved share schemes and options granted before 27 November 1996

These rules have no impact on Inland Revenue approved employee share and share option schemes [see SSM 2.1), nor on options over shares in unapproved schemes granted before 27 November 1996 (see SE11851), which remain outside PAYE.

Release of share options

Section 203FB also requires PAYE to be operated on payments to employees, either in cash or in readily convertible assets, in return for giving up or not exercising a share option. These payments are taxable under Section 135 and are sometimes known as “release” or “cancellation” payments.

Where these payments were made in cash before 6 April 1998 there was a tax charge under Section 135, but no obligation to operate PAYE.

Unlike gains on exercise of options, PAYE applies to all cash release payments, including those paid to employees for not exercising options over shares in approved schemes and those paid to employees for not exercising options over shares in unapproved schemes granted before 27 November 1996 – see example SE11862.

Where an option is released or cancelled in return for cash, the person paying the cash must operate PAYE. Where an option is released or cancelled in return for a readily convertible asset, the person who was the employer at the time the option was granted must operate PAYE.