ERSM110010 - Securities Options: what are securities options?

When a company grants an employee a securities option, the employee is not given securities outright, but is given the right to acquire them under certain conditions. Sometimes the employee will pay something for the option. A securities option is defined in the legislation (ITEPA03/S420 (8)) as a right to acquire securities. Such a right can be granted over any type of security. The legislation therefore covers more than a “share option”, as the term is normally understood.

A share option, as the term is normally understood, will normally set out: -

  • the number of shares the employee can buy,
  • the price (if any) the employee will pay for those shares,
  • the dates from which, and by which the employee must exercise the option
  • any conditions affecting the rights to exercise.

An option is exercised when the employee acquires the shares - in other words, has exercised his rights under the option.

The wider definition of “securities option” as a right to acquire securities encompasses arrangements that do not require an “exercise” by the holder of the option in order for her to acquire the shares. Some arrangements falling under the generic description of Long Term Incentive Plans (LTIPs) involve the employee being given a right to receive shares at the end of a “vesting period”. At the end of the vesting period, the employee does not need to do anything to acquire her shares; she simply acquires them as is her right under the LTIP. (For further discussion of LTIPs, see ERSM20192)

The main rules dealing with options from 16 April 2003 are in Chapter 5 of Part 7 of ITEPA 2003.

It is very common for some or all of the shares to be sold at the time that they are acquired (by exercise or otherwise), although for practical reasons the sale may not actually take place until a few days after the acquisition. This may be so that the employee can fund the exercise price (the amount to be paid for the shares), and the tax and NICs liability on the option gain. An employee may also prefer the certainty of cash in his hand immediately.

Example

On 1 January 2005, Simon is granted an option over 5,000 shares in the company he works for, United Dyers plc, at £3 per share. He can exercise the option at any date between 1 January 2008 and 31 December 2008. On 1 January 2005 the market value of the shares was £2.74. Simon watches the share price rise, and decides to wait until the final month of the option’s life before exercising his rights. In December 2008 the shares are worth £4.80. Simon buys 5,000 shares for £15,000 and immediately sells them for £24,000, making a £9,000 gain. That gain is chargeable to Income Tax under Chapter 5 Part 7 ITEPA 2003 - see ERSM110510. National Insurance Contributions will also apply.

Options used in avoidance

See ERSM20200 on securities options used in avoidance.