SE11860 - PAYE on share transactions: example 1 - exercise of an option in an unapproved share option scheme

Example 1

• On 21 April 1999 an employer grants an employee an option over 2,000 shares in the company’s unapproved share scheme at £1 per share
• the employer is a private company, not listed on any exchange
• the option can be exercised between 1January 2000 and 31 December 2003
• on 20 October 2001 the share value reaches £5, the employee exercises the option and acquires 2,000 shares worth £10,000
• the shares cannot be sold immediately, but each year on 31 December the employer organises a “share sale”, at which the company repurchases at market value any shares that employees wish to sell.

Is the employer obliged to operate PAYE?

There is an income tax charge on £8,000 (representing the value of the shares acquired when the option is exercised less the amount paid for the option) at the time the option is exercised under Section 135 ICTA1988. There is no income tax charge at time of grant because the option cannot be exercised more than 10 years later (see Share Schemes Manual 3.3).

The shares are in an unlisted company so neither of the definitions of readily convertible asset in Sections 203F(2)(a) ICTA1988 (see SE11804) nor in (b) (see SE11805) applies, but when the employee acquires the shares on 20 October 2001 he knows that on 31 December it is likely the employer will buy them back at market value.

This knowledge amounts to an understanding that trading arrangements are likely to come into existence and, by virtue of Section 203F(2)(g), the shares are readily convertible assets (see SE11810). Consequently the employer must operate PAYE on £8,000 at the time the option is exercised.