ERSM70410 - Securities Acquired for less than Market Value

Residence: acquisition of securities by exercise of option granted overseas

Interaction of Chapter 3C with Chapter 5 (securities options)

Chapter 5 Part 7 ITEPA 2003 (securities options) exempts employees who subsequently become resident and ordinarily resident in the UK from the charge at exercise, where the options were granted in a tax year when the employees were not resident and ordinarily resident, or were resident but not ordinarily resident (old Case II Schedule E), such that the provisions of ITEPA03/S15 or ITEPA03/S21 did not apply to their general earnings.

Such employees may subsequently acquire securities through the exercise of their options in the UK without a charge arising under Chapter 5.

As mentioned at ERSM70010. the forerunner of Chapter 3C was introduced to tackle avoidance using partly-paid shares. 3C applies to securities acquired for less than market value. However, it was quickly noticed that it also taxed options exercised by employees who were not ordinarily resident and were therefore not within the options legislation, now at Chapter 5.

”Legal options” and other securities options

“Legal option” is used here to describe an option which is a contractual legal entitlement given by one party (usually the employer) to another, for consideration or under deed or seal (see also ERSM110010). Where the option is granted under foreign law, other factors may be relevant.

Chapter 5 has a broader definition of securities option, being any right to acquire securities. Chapter 3C is confined neither to legal options nor to securities options but applies more generally, to securities acquired for less than market value.

Long term incentive plans (LTIPs) and similar arrangements conferring rights to acquire securities often involve an agreement or promise that falls short of being a legal option.

The distinction between legal options and other securities options is important because of the case of Abbott v Philbin (see ERSM110100). The option in that case could be turned into money at the date when it was granted, even though it could not be transferred: Mr. Abbott could have made an agreement with a third party to exercise the option and transfer the shares to that third party. But we do not accept that the same can be said for the promise made under an LTIP that falls short of being a legal option. In such cases the value of the securities awarded under the plan is likely to be chargeable as money’s worth.

Legal options granted when employee is not resident and not in respect of UK duties

Such an acquisition of securities for less than their market value might be caught by Chapter 3C. However, the right or opportunity to acquire securities pursuant to an option arises when that option is granted (ITEPA03/S420B(8)). The employment in question is therefore the employment at the time of grant. If the employee were then resident wholly overseas (and the grant were not in prospect of taking up the UK employment or otherwise in respect of duties performed in the UK), then the right or opportunity would arise in respect of an employment outside the scope of UK tax and HMRC's practice is not to pursue a Chapter 3C liability.

Only where a “legal option” is granted to an employee in respect of an employment that is not within the charge to UK tax at the date of grant will the exercise of that option and the acquisition of securities for less than their market value be outside both:

• a charge under Chapter 3C, and
• a money’s worth charge.

See ERSM70450 where LTIPS, etc., not constituting legal options are granted abroad and ERSM20500 for details of the money’s worth charge.

“In respect of UK duties”

An example of a situation where HMRC would maintain that the grant of an option was in respect of UK duties would be where an employee is on a 2-year secondment to the United States and half way through Year 2 he is granted a 3-year option when he knows he is returning to the UK. The exercise of that option in the UK is likely to incur liability under Chapter 3C as at the time of grant it was known that there would be two and a half out of three years work in the UK to “earn” those shares.  A contrary scenario might involve a US citizen who receives his regular share option on, say, 1st January and two months later is invited to go on secondment to the UK.  In those circumstances, where the employee has no prior knowledge of the secondment, we will not seek a charge under Chapter 3C.

Legal options granted when employee is not within Chapter 5 – the money’s worth charge

Under ITEPA03/S475 there is no charge to income tax on the acquisition of a securities option to which Chapter 5 applies. Where Chapter 5 does not apply, for example where there are no general earnings for the purposes of ITEPA03/S15 or ITEPA03/S21, but the employee is within the charge to UK tax by virtue of other provisions of Chapter 5 of Part 2 of ITEPA03, then there may be a money’s worth charge in respect of the value of the option when it is granted, in addition to any Chapter 3C charge on exercise of the option. (See also ERSM110110 and EIM00540 onwards)