ERSM220060 - Valuation Issues

“Market value” – cashless exerciseAn employee wishes to exercise an option to acquire securities in the listed employing company or its parent company at an exercise price of, say, £1 when the quoted price is £5. Before the option is legally exercised, the employee agrees with the employer to what is often referred to as a “cashless exercise”. This means that, at the point of exercise, either:

  • sufficient securities will be sold immediately to cover the exercise price and the PAYE/NIC with the remaining securities being passed to the employee, or
  • the entire holding will be sold with the net proceeds of sale, after retention of amounts to cover the PAYE/NIC, being passed to the employee. There can be difficulties in establishing the market value for the purposes of calculating the gain on exercise, because the broker may sell the securities in various tranches during the day so as not to flood the market. Prices fluctuate during the day and the price or prices obtained may not equal the “quarter-up” figure as required by TCGA92/S272.

Normally the market value of listed securities, i.e. the amount those securities might reasonably be expected to fetch on a sale in the open market, is arrived at using the prices in the Stock Exchange Daily Official List, which is prepared at the end of each day’s trading.

Alternative basis for valuationHowever, it is sometimes possible to ascertain a precise figure for the market value of the securities acquired. This can be done where, prior to the exercise of the option, the employer and employee have entered into a contract, arrangement or agreement (the cashless exercise) and as a result the employee is obliged to sell at least the number of securities required to fund the exercise price and/or the PAYE/NIC liabilities immediately after exercise.

In those circumstances, provided the sale is in the open market, the market value per security of all the securities acquired on the exercise of the option may be accepted as equal to the sale price per security sold for the purposes of computing the option gain under ITEPA 03/S477. The same value will be used both for the securities acquired and immediately sold and for any securities retained.

Sales extend into following dayNormally with a cashless exercise the exercise and sale will take place on the same day. There may be circumstances where, with an exercise late on Day One and large number of securities placed with the broker, that the sales extend into Day Two. HMRC will accept the cashless exercise treatment whereby the actual sale price is used in these circumstances.

Where sales extend beyond the second day the quarter-up price for Day One will need to be used for establishing market value at exercise.

Averaging of dealsWhere a large number of deals extend over one or two days and the proceeds acquired by each employee are the average sale price for all employees, that price may be used for each employee.

Tax or NIC avoidanceHowever, where one or all of the purposes of a contract, arrangement or agreement, which purports to be a cashless exercise, is the avoidance of tax and/or NIC then the market value of the securities sold may not provide an accurate measure of the amount which the securities “might reasonably be expected to fetch on a sale in the open market”. In such circumstances the price given by the Official List will be appropriate.