SE11862 - PAYE on share transactions: example 3 - option cancelled in return for payment

Example 3

• On 25 November 1996 an employer grants an employee an option for £1 per share over 1,000 shares in the company unapproved share scheme
• the employer is a private company not listed on any exchange
• the option must be exercised between 26 November 1999 and 24 November 2006
• in 2001 the employer company is taken over and the new owner cancels the employee’s existing option in return for a cash payment of £5,000.

Is the employer obliged to operate PAYE?

Under Section 135(8) ICTA 1988 when an employee assigns or releases an option an income tax charge arises on the difference between the amount paid to the employee and the amount (if any) paid for the option (see Share Schemes Manual 3.16). In this case there is a charge on £4,000.

Under Section 203FB(3)(a) ICTA1988 the person making the cash payment is obliged to operate PAYE on this release payment. Please note that if the option had been cancelled in return for a readily convertible asset (e.g. shares in the new company) the employer when the option was originally granted would have to operate PAYE under Section 203FB(3)(b). If the option holder is no longer an employee of that person see SE11920.

It is important to remember that whilst PAYE generally applies under the readily convertible asset rules only to unapproved share schemes and to share related events since 27 November 1996 (see SE11851), PAYE applies to cancellation or release payments even if

• the cancelled option was granted before 27 November 1996
• the option relates to shares in an Inland Revenue approved scheme.

See SSM Chapter 2 for information on the taxation of Approved Share Schemes.