BIM44410 - Specific deductions: employee share schemes: providing shares to employees: qualifying shares: cash cancelled and net settled share options

S1038, S1038A Corporation Tax Act 2009

When share options are granted, under generally accepted accounting practice (GAAP) the employer (or for group structures, the entity receiving the services of the employee) should recognise an amount in respect of the services provided by the employee in respect of the option. The amount is calculated based on the fair value of the option at grant, spread over the vesting period of the option. This is known as the Share Based Payment (SBP) expense. 

S1005 CTA09 defines an option as including “any right to acquire shares”, which could include arrangements such as Restricted Stock Units (RSUs). If in any doubt as to whether an arrangement meets this definition of a share option, please refer to the BAI Business Profits Team for further advice.    

For options, in most cases a deduction is denied under S1038A CTA09 for any matter connected to the option, including the SBP expense, until shares are acquired. If there is any doubt as to whether S1038A applies to deny a deduction for an option, please contact BAI Business Profits Team.

When shares are acquired as a result of an option, if the relevant conditions are met (see BIM44270), the statutory deduction under Part 12 CTA09 will be available and S1038 CTA09 continues to deny a deduction for any other expense, including the SBP expense. 

But there are some circumstances where a deduction will be available for the SBP expense.

Cash Cancelled Share Options 

Options may be cancelled for a number of reasons. On cancellation, the employer will often make a cash award to the employee and in most cases the cash award will be an amount equivalent to the fair value of the option at the time of cancellation. We refer to these as cash cancelled share options.  

The cash payment for the fair value of the option at the date of cancellation is not usually recognised in the profit or loss account and is normally debited to equity. A SBP expense will have been recognised in each period between grant and cancellation but a deduction will have been denied by S1038A(2). In the accounts (for the period in which the cancellation takes place) the cancellation is treated as an acceleration of vesting of the options, meaning that those accounts include an expense for the amount that would otherwise have been spread over the remainder of the vesting period.

These awards are subject to a charge on the individual under ITEPA 2003 but as no shares are actually acquired by the employee, Part 12 CTA09 does not provide a corresponding statutory deduction for the employer.   

Net Settled Share Options 

When a share option is exercised, the employer may retain a proportion of the shares in order to settle the tax and National Insurance liabilities of the employee. These are known as Net Settled share options.

A Part 12 CTA09 statutory deduction will be available to the employer in respect of any shares acquired by the employee, but no statutory deduction under Part 12 CTA09 is available for the proportion of shares retained by the employer. This is despite the employee incurring tax and National Insurance liabilities on the full benefit of the option, as if the employee had acquired all of the shares.

Under GAAP, the SBP expense on grant of the option will have been recognised over the vesting period of the option, but a deduction will have been denied by S1038A(2).  

There are other similar situations where all of the shares are awarded to the employee but a number of shares equal in value to the employee’s ITEPA liability are sold through a broker in order to settle the ITEPA liability. These are sometimes known as Sell to Cover and as a Part 12 statutory deduction would be available for the whole award, S1038 would deny a deduction for the SBP expense. These arrangements are the same as any other option where all of the shares are awarded on exercise of an option (see BIM44260 to BIM44405). 

It is possible that a full Part 12 statutory deduction will incorrectly be taken for the exercise of an option that has been net settled, and the exercise being net settled may not be apparent from the accounts. Where there is any doubt, you should establish the details of the arrangements to determine whether shares awarded on exercised options are acquired in full by the employee, or are subject to Net Settled or Sell to Cover arrangements.