The Social Security Contributions (Share Options) Act 2001- Guidance on the Special Provisions for Roll-overs

The Social Security Contributions (Share Options) Bill received Royal Assent on the 11 May 2001. The Act concerns the National Insurance liability in respect of share options that were granted to employees during the period 6 April 1999 to 19 May 2000. Under the new legislation employers can settle the NIC liability arising on options granted during that period by using the share price on 7 November 2000 to calculate the gain on which NIC are due.

In order to cap the NIC in this way a notification and appropriate payment had to be sent to the Inland Revenue within 92 days of Royal Assent of the Act. The last day for settlement was 10 August 2001. The NIC payable is a special employer only contribution of 12.2% of the deemed gain. Where the amount of the special contribution would be nil notification is deemed to have been made so the NIC on all such options is automatically relieved.

Where the special contribution has been paid on an option the Class 1 liability on any actual share option gain is removed. However, there are special rules concerning an assignment or release of an option, where some Class 1 liability may still arise should the consideration given for the assignment or release be in excess of parity. We expect that this will only rarely happen. However, this guidance explains those rules further and looks in particular at the special provisions contained within the Act where the assignment or release features a rollover of an option.

All legislative references are to the Social Security Contributions (Share Options) Act 2001 unless otherwise stated. The examples given assume that the shares are readily convertible assets. See 8.2.

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1. When you need to consider this guidance

This guidance needs to be considered where the special contribution was paid by 10 August 2001 in settlement of the Class 1 NIC liability (or the Class 1 NIC liability is deemed to have been settled under the Act) and the option is subsequently assigned or released.

In the rest of this guidance options in respect of which a special contribution has been made or is deemed to have been made will be referred to as "settled options". This includes options received between 20 May 2000 and 7 November 2000 in consideration for an option originally granted between 6 April 1999 and 19 May 2000 and settled or deemed to have been settled under the Act.

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2. General Parity Test

The first step is to consider whether the consideration given for the assignment or release meets the parity test. This is a test that broadly compares the value received with the amount that would have been received if the settled option had been exercised on that day.

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2.1 Does the consideration given meet the parity test?

Subsection 2(3) of the Act concerns the exemption from Class 1 liability on the event of the assignment or release. The exemption in subsection 2 (1) is restricted where the consideration given for the assignment or release exceeds the inherent gain in the settled option at the time of such assignment or release. The amount in excess of the inherent gain will remain subject to the existing Class 1 rules.

Test 1: Parity Test on assignment or release (s2(3))

Parity met if:

Consideration given for assignment or release of option is less than or equal to the gain that would have been taxable under s135(3) ICTA had the option been fully exercised immediately before its assignment or release.

If the parity test is met there will be no Class 1 due on the event of the assignment or release itself.

The consideration given for the assignment or release of the settled option can of course take many forms. Example 1 considers the situation where the consideration given for the assignment or release of a settled option does not include a new option. The latter part of this guidance looks at assignment and release where a new option forms some or all of the consideration given i.e.: rollovers.

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2.2 Consideration for assignment or release of option (excludes grant of new option)

Looking first at the situation where a new option does not form all or part of the consideration given:

Example 1: no option in consideration package - parity release

A is granted an option on the 5 December 1999 to acquire 100 shares at an exercise price of £1 per share which is equal to the market price on that date. His employer gave notice under the legislation to "cap" the Class 1 contributions. On 7 November 2000, the total market value of the shares subject to option is £1,100, resulting in a special contribution of £122 (being (£1100 - 100) x 12.2%).

After settling the option, the employer and employee agree that the employee will surrender the option for cash of £5,000. At that time the market value of the shares under the option is £5,100. The consideration given is equal to the inherent gain in the option (i.e. (£5,100 - £100) = £5,000) and the release was therefore at parity.

In example 1 the parity test is met. Although the total value of the consideration given for the release of the settled option is higher than the amount on which the special contribution was paid, the consideration did not exceed the option's inherent value at the time of the assignment or release. Therefore, there will be no Class 1 liability at the time of the release of the settled option in exchange for the cash and shares.

Example 2: no option in consideration package - non-parity release

After settling the option, the employer and employee agree that the employee will surrender the option for cash of £10,100. The market value of the shares under the option at that time is £5,100 so the inherent gain is £5,000 (being £5,100 - £100). In these circumstances, the amount to include in earnings for the purpose of Class 1 contributions will apply at the time of the release of the option under section 4(4)(a) SSCBA 92 and will be £5,100 (being £10,100 - £5,000).

In example 2 the release was not at parity because the consideration given exceeded the inherent gain. Note that it is not the whole of the increased gain since settlement that comes back into liability, only the amount which relates to the excess given above parity at the time the settled option was released.

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SPECIAL PROVISIONS FOR ROLL-OVERS

3. General

If all or part of the consideration given is in the form of a new option then the rollover provisions contained within section 3 of the Act will apply. These rules are explained further below.

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3.1 When the rollover provisions will apply

The special provisions apply where:

The settled option was obtained in the period 6 April 1999 - 19 May 2000; or
The settled option was obtained in the period 20 May 2000 and 7 November 2000 (where received as a result of a rollover of an option originally obtained in the period 6 April 1999 and 19 May 2000); and
That settled option has been assigned or released for consideration which includes a new option.

These provisions will apply whether the "new" option is over shares in the same company or a different company. The rollover of the settled option may occur at any time.

The rollover provisions achieve the following:

They allow settled options to remain settled in the event of a subsequent rollover where the option was rolled over at parity; whilst
Ensuring that Class 1 will remain due on the consideration given in excess of the settled option's value.

One of the reasons why the rollover provisions are complex is because the Act caters for:

Straightforward rollovers i.e. settled option A surrendered for option B
Multiple rollovers i.e. settled option A rolled over into option B rolled over into option C etc
Mixed packages e.g. settled option A surrendered for option B plus cash
Multiple rollovers combined within mixed packages.

This guidance looks at each of these scenarios.

Where the settled option is rolled over in excess of parity, only the gain attributable to the amount of the new option in excess of a parity exchange will come back into Class 1 at the time when the final gain is made, not the full gain since settlement. This ensures that the amount of the gain attributable to an increase in the share price (rather than as a result of being given a bigger option) remains capped.

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3.2 Options rolled over before notification given

The Act allowed a notice to be given where the option was rolled over before the notice is made.

For settled options rolled over before 8/11/00 (s3(2)) - the new option is treated as if it was received between 6 April 1999 and 19 May 2000 (inclusive). The notification is given in respect of the replacement option (i.e. that received in the period 20 May 2000 to 7 November 2000) but the cap is limited (by s3(5)) to the extent of the settled option.
For settled options rolled over between 8/11/00 and the date notice given (s3(3) - notifications were possible in respect of the original option not withstanding that it was rolled over before the notice was made.. The special provisions in section 3 will apply to the rollover made before the notification was given.

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4. Option for option exchange

This is where a new option forms all of the consideration given for the settled option. In these cases there will be no Class 1 NIC due on the event of the rollover itself (by virtue of s136 ICTA). Section 2(1) provides the exemption from liability under Class 1 on gains for options on which a notification has been made. Section 3(5) removes the S2(1) exemption for gains on the replacement option or of any subsequent replacement right. Instead, a new basis for assessing Class 1 liability is provided by s3(6). The effect of this is to leave a Class 1 liability on the amount of the gain on the replacement option that relates to the part of the new option that was in excess of the settled option measured by reference to parity at the time of the rollover. If the rollover was at parity no Class 1 NIC will arise on the gain made on the replacement option.

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4.1 Is the rollover at parity?

The tests are provided in s3(10) and (11). In an option for option exchange you need to consider whether the value of the new option was equal to the value of the settled option.

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Test 2: Parity Test in Option Rollover (s3(11))

To ascertain whether the rollover was at parity (i.e. to calculate whether there are any additional shares) compare:

(a) the amount of the share option gain of the new option that would be taxable under s135 ICTA had it been exercised as soon as it had been given; to

(b) the amount of the share option gain of the old option that would be taxable under s135 ICTA had it been exercised immediately before its assignment or release.

If (a) is less than or equal to (b) then the option rollover was at parity.

Where the rollover was at parity no Class 1 NIC will arise on either the event of the rollover itself or on any actual share option gain of the new option as a result of the rollover.

Example 3: option for option exchange - parity rollover

A is granted option X on the 5 December 1999 to acquire 100 shares at an exercise price of £1 per share which is equal to the market price on that date. His employer gave notice under the legislation to "cap" the Class 1 contributions. On 7 November 2000, the total market value of the shares subject to option is £1,100, resulting in a special contribution of £122 (being £1100 - 100 x 12.2%).

After settlement the employer and employee agree that the employee will surrender settled option X for a new option Y. Option X is released on the 1 June 2002 when the shares under option are worth £11 each. Option Y is over 200 shares at an exercise price of £0.50. The market value of a share under option Y immediately after it is given is £5.50.

At the time of the rollover, the inherent gain in X is £1,000 (calculated as 100 x (£11 - £1) which is equal to the inherent gain in Y of £1,000 (calculated as 200 x (£5.50- 50p)). Therefore using the test in s3(10) and (11) the rollover was at parity.

In example 4 the rollover was not at parity. Where the test identifies a non-parity rollover Class 1 NIC will not arise on the event of the rollover itself in an option for option exchange. But Class 1 will arise on part of any gain made on the new option. The amount of the gain on the new option that will remain subject to Class 1 is calculated by reference to the amount of "additional shares". The element of the gain on the new option that relates to the number of additional shares will remain subject to Class 1 NIC.

Example 4 (part 2): option for option exchange - non-parity rollover

Calculation of Class 1 Liability on exercise of new option

Option Y is exercised when the share price is £15. The gain subject to income tax (under s135 ICTA 1988) is £2,900 i.e.(£15 - 50p) x 200. The gain relating to one hundred shares is protected from NIC liability by the settlement notification i.e. (£15-50p) x 100 = £1,450. The gain of £1,450 on the 100 `additional shares' will be subject to Class 1 NIC.

So the amount of earnings subject to Class 1 NIC will be £1,450 i.e. (£15-50p) x 100 = £1,450 by virtue of s4(4)(a) SSCBA 92 and will be brought within charge at the time of the gain on the new option.

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4.2 Gain on replacement option other than by exercise

If the gain on a replacement option is realised other than by way of exercise, it is necessary to consider whether the consideration given is equal to the replacement option's inherent gain, using the check shown in test 1 above. Again, if the parity test is met no Class 1 NIC will arise on the actual gain on the replacement option, unless the preceding rollover failed the parity test.

Example 4, part 3 illustrates where the consideration given is equal to the option's inherent gain, where the preceding rollover was not at parity.

Example 4 (part 3): option for option exchange - non-parity rollover

Calculation of Class 1 Liability where replacement option assigned or released for consideration equal to option's inherent gain

Option Y is surrendered for cash of £2,900 when the share price is £15. The gain subject to income tax (under s135 ICTA 1988) is £2,900. The inherent gain on one hundred shares (or £1,450 of the gain) of option Y are protected from Class 1 NIC liability by the settlement. The balance of the consideration given (i.e. £2,900 - £1,450) will be subject to Class 1 NIC.

Example 4, part 4 illustrates a case where the consideration given for the assignment or release of an option is greater than the option's inherent gain, where the preceding rollover was not at parity.

Example 4 (part 4): option for option exchange - non-parity rollover

Calculation of Class 1 Liability where replacement option assigned or released for consideration in excess of option's inherent gain

Option Y is surrendered for cash of £4,000 when the share price is £15. The gain subject to income tax (under s135 ICTA 1988) is £4,000. The inherent gain on one hundred shares (or £1,450 of the gain) of option Y are protected from Class 1 NIC liability by the settlement. The consideration given in excess of the option's inherent gain of £1,100 (i.e.: £4,000 - ((£15 - 50p) x 200) plus 50% of the option's inherent gain will be subject to Class 1 NIC.

The amount of earnings subject to Class 1 NIC will therefore be £2,550 (i.e. £1,450 + £1,100).

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4.3 What happens if a replacement option is exercised gradually?

If an option which was rolled over at parity is subsequently exercised in parts each exercise will remain free of Class 1 NIC by virtue of the settlement notification. This may occur for example, where the employee's option vests gradually.

The legislation provides (in subsection 3(12)) for circumstances in which there is an exercise, assignment or release of an option in part where that option comprises additional shares i.e.: where there has been a non-parity rollover. On a partial exercise the additional shares comprised in the option will be treated as exercised, assigned or released first before any right to acquire shares which are not additional shares. This is generally of benefit to companies because it ensures that "additional shares" are dealt with first reducing the scope of including future growth in the share price within the existing Class 1 rules.

Example 4 (part 5): option for option exchange - non-parity rollover

Calculation of Class 1 Liability on phased exercise of new option

Option Y is subject to a vesting schedule. The option vests over 100 shares in June 2003 and the vested part of the option is exercised on that date when the share price is £15. The gain subject to income tax (under s135 ICTA 1988) is £1,450 ((£15 - 50p) x 100).

Remember that the gain attributable to one hundred shares is protected from NIC liability by the settlement and the inherent gain on the remaining 100 "additional shares" will be subject to Class 1 NIC.

Subsection 3(12) requires that the additional shares comprised in the option will be treated as exercised, assigned or released first. So all of the gain on the first exercise in this instance will be subject to Class 1 as the gain is treated as arising from additional shares. The amount of earnings subject to Class 1 NIC will be £1,450 by virtue of s4(4)(a) SSCBA 92 and s3 of the Share Options Act 2001.

The remaining part of the option vests and is exercised on 1 June 2004 when the share price is £18. As the previous exercise comprised all of the additional shares no further Class 1 liability will arise on the second exercise.

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4.4 What if the option surrendered was underwater?

In an option for option exchange, if an underwater option is rolled over for a market value option i.e.: the new option is not discounted, the parity test will be met and the gain on the new option will not be subject to Class 1 NIC. The new option may, however, be a discounted option i.e. the exercise price is less than the market price on the date of grant. If the underwater option is surrendered for a discounted option the rollover will fail the parity test. The amount of the discount to market value will be considered to be the excess over parity (rather than the difference between the "loss" in the old option and the inherent gain in the new at the time of rollover).

Example 5: rollover of underwater option

Parity rollover

A is granted an option X on the 5 December 1999 to acquire 100 shares at an exercise price of £10 per share which is equal to the market price on that date. His employer gave notice under the legislation to "cap" the Class 1 contributions.

After settlement the employer and employee agree that the employee will surrender option X for a new option Y. Option X is released on the 1 June 2002 when the market price of the shares under option have fallen to £5 each and consequently the option X is "underwater" by £5 per share. Option Y is also over 100 shares but at an exercise price of £5 which is equal to the market price at that date. The inherent gain in X is nil as is the inherent gain in Y. Therefore the rollover is considered to be at parity.

Non-parity rollover

The same scenario as above except that option Y is granted at a discount, the exercise price of Y being £2.50 per share. The inherent gain in X is nil. The inherent gain in Y is £250 ((£5 -£2.50) x 100) i.e. the amount of the discount. Therefore the rollover was in excess of parity by £250. So, 50 shares in option Y (being £250/(£5) are "additional shares". Class 1 NICs is payable in respect of those additional shares when the gain is made.

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5. Multiple rollovers (option for option)

This is where a settled option is rolled over on more than one occasion and on each rollover a new option forms all of the consideration given for the old option. In these cases there will be no Class 1 NIC due on the event of each rollover (by virtue of s136 ICTA). As with single rollovers, s3(5) removes the exemption from the liability to pay Class 1 contributions on the gain (provided in s2(1) for options on which a notification has been made) on the replacement option or of any subsequent replacement right. A new basis for assessing Class 1 liability is provided (by s3(6)).

With multiple rollovers the test of parity should be applied at each rollover and on any ultimate gain made by assignment or release. At each rollover it is necessary to apply s 3(10) and (11) (shown in test 2 above), comparing the inherent value of the option being surrendered to the new option and to recalculate the element, if any, in the new option which is additional shares. The new figure calculated is then carried forward for use to assess any Class 1 NIC which remains liable under s4(4)(a) of the Social Security Contributions and Benefits Act 1992 on the eventual option gain. If the option is subsequently rolled over again, it is the newly calculated additional shares figure that is used when reassessing the parity test for s3(10). This is best illustrated by the following example.

Example 6: multiple rollovers - non-parity rollover

A is granted an option X on the 5 December 1999 to acquire 100 shares at an exercise price of £1 per share which is equal to the market price on that date. His employer gave notice under the legislation to "cap" the Class 1 contributions. On 7 November 2000, the total market value of the shares subject to option was £1,100, resulting in a special contribution of £122 (being £1100 - 100 x 12.2%).

Rollover 1

After settlement the employer and employee agree that the employee will surrender option X for a new option Y. Option X is released on the 1 June 2002 when the shares under option are worth £11 each. Option Y is over 200 shares at an exercise price of £0.50. The market value of a share under option Y immediately after it is given is £10.50.

Applying the parity test, first consider the inherent gain in X (for s3(11)(b)) which is £1,000 (calculated as (£11-£1) x 100). Next calculate the inherent gain in Y (for s3(11)(a)) which is £2,000 (calculated as (£10.50-50p) x 200). Therefore for the purposes of s3(11) these two values are not equal, the rollover being in excess of parity by £1,000.

Next it is necessary to calculate the additional shares applying s3(10). The excess over parity is £1,000. The number of shares that would produce that gain in option Y is calculated as 100 (being £1,000/(£10.50-50p). Therefore 100 shares are `additional shares' i.e. 50% of option Y which is in excess of parity.

Rollover 2

On 1 June 2003 option Y is released in exchange for option Z when the shares under option Y are worth £15.50. Option Z is over 200 shares at an exercise price of £1. The market value of a share under option Z immediately after it is given is £18.50. The inherent gain in Y is £3,000 ((£15.50 - 50p) x 200). The inherent gain in Z is £3,500 ((£18.50- £1) x 200).

Using s3(10) and (11) it is necessary to find out whether the second rollover is at parity. But as this is a multiple rollover it is necessary to disregard for the purposes of the parity test any shares under the option being surrendered that were themselves "additional" so that the proportion of option Y being used in the test is that protected by the settlement. So, although the inherent gain in Y is £3,000, £1,500 (being 100 x (£15.50-50p)) of that gain is attributable to the "additional shares" and is therefore put to one side for the purposes of this test. This will identify the parity element in option Y (i.e.: the inherent gain net of the additional shares from previous rollover) which should then be compared to the inherent gain in Z of £3,500. The excess is £2,000 (being £3,500 - £1,500).

Next, calculate the new additional shares number by dividing the new "excess parity" figure of £2,000. The number of shares that would produce that gain in option Y is calculated by dividing the excess element of £2,000 by the inherent gain in each share (i.e.: £2,000/(£18.50-£1). Therefore 114.29 shares under option Y are `additional shares' i.e. 57.14% of 200 shares.

Final Gain

Option Z is eventually exercised on 1 June 2005 when the share price is £21. The taxable gain would be £4,000 ((£21-£1) x 200). The amount of the gain that should be subject to Class 1 NICs is £2,286 (114.29 x (£21 - £1) the balance of the gain remaining protected by the settlement.

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6. Single rollover of option for new option plus other consideration

This is where a settled option is assigned or released for consideration which consists of a new option plus some other form of consideration, which is usually cash but could be shares, for example. Where the consideration is "mixed" in this manner it is necessary to consider both the potential Class 1 NIC liability on the event of the assignment or release itself plus any potential liability on the new option gain. The legislation is structured so that when the test of parity is considered at the time of the rollover, the new option is applied to the parity element first so that any excess over parity is weighted towards the non-option (i.e. generally cash) element of the consideration. It is structured this way to minimise the likelihood that future share price growth in the option will be subject to NIC.

The first step is to consider whether any Class 1 liability will arise on the event of the assignment or release for mixed consideration itself. This again is determined by the first test (shown above) given at section 2(3) of the Act. The value of the new option to be used in the test is provided by section 3(4) which operates in conjunction with section 2(3). Section 3(4)(b) provides that the value of the option for the purposes of the test in 2(3) is determined as follows.

Test 3: Value of option to be used in Test 1 upon a first rollover where consideration includes option plus other assets.

The value of the new option that should be used in section 2(3) of the Act is provided by s3(4) and is the smaller of:

(a) the amount of the share option gain of the new option that would be taxable under s135 ICTA had it been exercised as soon as it had been given (s3(4)(b)(ii)); and

(b) the amount of the share option gain of the old option that would be taxable under s135 ICTA had it been exercised immediately before its assignment or release (s3(4)(b)(i)).

The value provided by test 3 is then used to determine the value of the total consideration in section 2(3)(a) given for the assignment or release. This will apply to the first rollover of the settled option only. (Part 7 of this guidance deals with the case where the option is rolled over again and shows that the value for test 1 is instead supplied by section 3(7) of the Act).

Example 7 (step 1): option for mixed package exchange - non-parity rollover

A is granted a market value option X on the 5 December 1999 to acquire 100 shares at an exercise price of £1 per share. His employer gives notice under the legislation to "cap" the Class 1 contributions.

Subsequently, the employer and employee agree that the employee will surrender option X for a new option Y plus cash of £700. Option X is released on the 1 June 2002 when the shares under option are worth £11 each. Option Y is over 100 shares at an exercise price of £0.50. The market value of a share under option Y immediately after it is given is £5.50.

So for the purposes of section 2(3)(a) the value of the new option is the smaller of:

(a) Inherent gain of old option i.e.: £1,000 ((£11-£1) x 100)

(b) Inherent gain of new option i.e.: £500 ((£5.50 - 50p) x 100).

Therefore, the value of the new option to be applied in test 1 is £500.

Test 1 is then applied to determine whether any NIC will apply on the assignment or release of the option on the non-option element of the consideration.

Example 7 (step 2): option for mixed package exchange - assessment of Class 1 liability on date of assignment or release

Using the test in 1.

(a) The value of the consideration given for option X (as determined by section 3(4)) is £500 (option Y) plus £700 (cash) = £1,200.

(b) The inherent value of option X was £1,000.

Therefore, the consideration is in excess of parity by £200. Class 1 NIC will arise on £200 at the time of the assignment or release.

The second consideration is whether any NIC will arise when the new option is exercised, assigned or released. To determine this it is necessary to consider whether test 2 is satisfied returning to the concept of additional shares.

Example 7 (step 3): option for mixed package exchange - assessment of Class 1 liability on new option gain

The parity test is applied by looking at the inherent gain of the old option compared to the new at the time of the rollover itself. S3(10) and (11) ignores the non-option element of the package for the purposes of assessing whether there are any additional shares.

The inherent gain in X is £1,000 and the inherent gain in Y is £500 (see step 1). Therefore, applying s3(11), there are no additional shares in the new option and therefore no Class 1 NIC due on the new option gain.

Note that even though the total consideration package was in excess of parity no Class 1 NIC will arise on the new option gain in this example because the excess in the form of cash was subject to Class 1 NIC at the time of the assignment or release itself. Where the total consideration given for an old option is in excess of parity he legislation is designed so that the non-option element will attract a NIC liability in priority to the gain on the new option.

Compare this to the following example where the "excess" consists of both option and cash.

Again, it is necessary to consider whether there will be any Class 1 NIC liability at two stages, on the event of the assignment or release comprising mixed consideration and then on the actual realisation of the gain on the new option. Steps 1 and 2 in example 8 illustrate how to assess whether there is any Class 1 NIC liability on the event of the assignment or release itself.

Example 8 (step 1): option for mixed package exchange - non-parity rollover

Subsequently, the employer and employee agree that the employee will surrender option X for a new option Y plus cash of £200. Option X is released on the 1 June 2002 when the shares under option are worth £11 each. Option Y is over 250 shares at an exercise price of £0.50. The market value of a share under option Y immediately after it is given is £5.50.

So for the purposes of section 2(3)(a) the value of the new option is the smaller of:

(a) Inherent gain of old option X i.e. £1,000 (100 x (£11-£1))

(b) Inherent gain of new option Y i.e. £1,250 (250 x ((£5.50 - 50p)).

Therefore, the value of the new option to be applied in test 1 is £1,000.

The next step is to assess the amount of Class 1 liability, if any, on the event of the assignment or release, as shown in the following example.

Example 8 (step 2): option for mixed package exchange - assessment of Class 1 liability on date of assignment or release

Using the test in 1 for s2(3).

(a) The value of the consideration given for option X (as determined by section 3(4) is £1000 plus £200 (cash) = £1,200.

(b) The inherent value of option X was £1,000.

Therefore, Class 1 NIC will arise on £200 cash at the time of the assignment or release.

The second stage is to consider whether any Class 1 NIC will arise when the gain is made through exercise, assignment or release of the new option. . This is illustrated in example 8, step 3. Step 3 illustrates how s3(10) and (11) ignores the amount of the cash consideration given for the old option for the purposes of assessing whether any of the shares are additional.

Example 8(step 3): option for mixed package exchange - assessment of Class 1 liability on new option gain

Using sub-sections 3(10) and (11) compare the inherent gain of the old option compared to the new at the time of the rollover itself.

The inherent gain in X is £1,000 and the inherent gain in Y is £1,250 (see step 1). The excess is therefore £250. 50 of the shares in the new option are therefore additional shares (being £250 / (£5.50 - £5)).

If the eventual inherent gain on option Y were £5,000 (being 250 x (£20.50 - 50p)), £1,000 would be subject to Class 1 (being 50 x (£20.50 - 50p)).

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7. Multiple rollovers where other forms of consideration are also given

This is where there is more than one rollover and the consideration given for the second or subsequent rollover consists of a new option plus other consideration, such as cash.

The parity test applied to the first rollover should be in accordance with the preceding paragraphs depending upon whether it was a straight option for option or mixed package.

The parity test for the second rollover again is in two parts. The first part deals with whether there is any liability on the event of the assignment or release itself on any non-option consideration. Subsection 3(7) says that the amount of the gain on which there would be a Class 1 liability at the time of the rollover itself (i.e.: on cash or any other asset which is not an option) is equal to the amount on which liability to pay Class 1 contributions would have been preserved. The amount on which such Class 1 liability would be preserved is determined in accordance with the assumptions given in subsection 3(8).

Subsection 3(8) provides that the value of the inherent gain that should be used in the parity test (the value calculated by test 3 above to be used in test 1) of the old option should be reduced by the amount of the additional shares. This will ensure that any Class 1 NIC taken on the event of the rollover itself (on consideration other than options) is adjusted so that the Class 1 liability on the rollover is preserved and no element is double charged.

The following example 8 (part 4) illustrates how to calculate whether there is any Class 1 on the event of the subsequent assignment or release itself.

Example 8 (step 4): option for mixed package exchange - assessment of Class 1 liability on event of subsequent rollover

(Following on from step 2 of example 8).

Subsequently, the employer and employee agree that the employee will surrender option Y for a new option Z plus cash of £250. Option Y is released on the 1 June 2004 when the shares under option are worth £7.50 each. Option Z is also over 250 shares at an exercise price of £0.50. The market value of a share under option Z immediately after it is given is £8.50.

So for the purposes of section 2(3)(a) the value of the new option is the smaller of:

(a) Inherent gain of old option Y i.e. £1,750 (being 250 x (£7.50 - 50p) less the 50 additional shares in option Y of £350 (50 x (£7.50 - 50p)) = £1,400* (observing s3(8)(c))

(b) Inherent gain of new option Z, i.e. £2,000 (being 250 x (£8.50 - 50p)).

Therefore, the value of the new option to be applied in test 1 is £1,400

* This is what distinguished the test from the test applied on the first rollover.

Example 8, step 5 illustrates how to apply test 1 to calculate the amount of any Class 1 that will arise on the event of the subsequent assignment or release.

Example 8 (step 5): option for mixed package exchange - assessment of Class 1 liability on date of assignment or release

Using Test 1.

(a) The value of the consideration given for option Y (as determined by section 3(4) modified by the assumptions in 3(8)) is £1,400 + the £250 cash = £1,650

(b) The inherent gain of option Y (again, observing s3(8)(c)) was £1,400.

Therefore, Class 1 NIC will arise on £250 at the time of the assignment or release.

The next stage is to consider whether any Class 1 NIC will arise on the event of the new gain on the subsequent option. This is illustrated in example 8, step 6. In step 6 the amount on which Class 1 has been paid at the time of the rollover itself is again ignored for the purposes of assessing whether any of the shares are additional. This ensures that the calculation of additional shares is reassessed on each subsequent rollover to preserve the liability on any excess whilst ensuring that no element is double charged.

Example 8 (step 6): option for mixed package exchange - assessment of Class 1 liability on subsequent gain

Comparing the inherent gain (as calculated in step 4) of the old option compared to the new at the time of the rollover itself, using sub-sections 3(10) and (11).

The inherent gain in Y is £1,750. But s3(1) requires that this is reduced by the amount of any additional shares so that it is the protected element in Y which is used for the parity test.. The inherent gain in Y net of the 50 additional shares (50 x (£7.50 - 50p)) is therefore £1,400
The inherent gain in Z is £2000.

The inherent gain in Z therefore exceeds the inherent gain in Y by £600. So, 75 (being £600/(8.50 - 50p))) shares in option Z are additional shares.

If the share price of Z when the eventual gain on option Z was made were £10 per share the gain that should be included in earnings for the purpose of Class 1 NIC by virtue of section 4(4)(a) SSCBA 92 would be:

(£10 - 50p) x 75 = £712.50

£1662.50 of the gain of option Z would remain free of Class 1 NIC by virtue of the settlement on option X.

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OTHER ISSUES

8 Transactions where there is an Inland Revenue approved rollover

There are several circumstances where the Inland Revenue may have agreed the basis for the rollover of approved options, such as where there has been a Scheme of Arrangement under s425 of the Companies Act 1985, a general offer or a de-merger. If the trading of shares under option may have been suspended at the date when a rollover is effected we will accept a rollover as being conducted at parity where:

A Share Schemes examiner has agreed the basis of the rollover of approved options;
The rollover of the unapproved options is being conducted on the same basis; and
The rollover is conducted within the relevant period

Similarly, if a cash or mixed package offer is made on terms accepted by a Shares Scheme Examiner for the purposes of an approved scheme, the assignment or release will also be accepted as being at parity.

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8.1 Options originally granted pre 6/4/99 and rolled over during 6/4/99 - 19 May 2000

Prior to 6 April 1999 NIC arose on the amount of any discount at grant of the option with no NIC being due on the actual share option gain. This was changed with effect from 6 April 1999 so that options granted after this date would attract Class 1 NIC on the share option gain. However, regulations include some transitional relief to protect options originally granted prior to 6 April 1999 and rolled over after 5 April 1999 from attracting a Class 1 charge on the gain on the new option provided that it was rolled over at parity. Further information can be found in Question and Answer 16 of Tax Bulletin 46 under Employee Share Plans. These exemptions are provided in Schedule 3 Part IX paragraphs 14 and 15 of The Social Security (Contributions) Regulations 2001 (CR 2001) (previously provided by regulations 19(1)(zl) and (zm) of The Social Security (Contributions) Regulations 1979. A basis of assessment of the gain on the new option i.e. the amount which relates to the excess of parity which remains chargeable under s4(4)(a) is provided in Schedule 2, paragraphs 10-12 of the CR 2001.

Where an option granted before the 6 April 1999 is rolled over during the period 6 April 1999 - 19 May 2000 and a Class 1 liability may arise on the new option because it was assigned or released in excess of parity, settlement may be given under the Act. The amount on which the special contribution is payable is the amount that would be chargeable had the option been exercised on the 7/11/00 i.e. the proportion of the gain that is in excess of parity, as determined by the CR 2001.

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8.2 Readily Convertible Assets

At each event (other than on the event of a rollover itself), when there is a potential amount to be included in earnings for the purposes of earnings related contributions, it is necessary to consider whether the earnings can be disregarded because the shares or the option itself are not readily convertible assets. So, for example, if a notification has been deemed to have been given (under s1(6) of the Act) where there is a subsequent assignment or release it will be necessary to consider whether the amount given breaches the parity rules, where any element of the consideration given is cash or readily convertible assets.

Conversely, even though a potential charge may be retained following a non-parity rollover, if the new option, or the shares under it are not readily convertible assets when the option is exercised, the amount will be excluded from earnings under the exemption provided in para 3 Schedule 3 Part IX of the CR 2001.

As under the current legislation, where an option is assigned or released for cash, there will be the potential for a Class 1 liability (on the amount of any excess over parity) regardless of the fact that the option itself and the shares under it were not readily convertible assets.

The rules for determining whether shares or options are RCAs under this Act are no different. Guidance is given in Tax Bulletin Issue 36 (September 1998).

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