ERSM70410 - Securities acquired for less than market value: acquisition of securities by exercise of option granted overseas up to 5 April 2015

Residence up to 5 April 2015 (see ERSM162000 for periods from 6 April 2015)

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

Chapter 5 Part 7 ITEPA 2003 (securities options) exempts employees who subsequently become resident in the UK from the Chapter 5 charge at exercise, where the options were granted in a tax year when the employee was not resident in the UK, such that the provisions of ITEPA03/S15, ITEPA03/S22 or ITEPA03/S26 did not apply to their general earnings.

(For options granted before 6 April 2008 the exemption applied to any employee who was not resident and ordinarily resident in the UK in the year of grant.)

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.

The distinction between what are termed in this guidance as “legal options” and other securities options relates to the decision in 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. Where a securities option is a contractual legal entitlement given by the employer to the employee, for consideration or under deed or seal, as was the case in Abbott v Philbin, it is likely to be money’s worth. But HMRC does not accept that the same can be said for all arrangements which would be securities options. For example, some Long-Term Incentive Plans (LTIPs) and similar arrangements might provide employees with a right to acquire securities but that right will not be money’s worth on award. In such cases the value of the securities awarded under the plan is likely to be chargeable as money’s worth.

The term “legal option” is therefore used here as shorthand for something that can be turned into money at the date when it is granted.

So while 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.

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/S421B(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.

When securities are acquired in a year when the employee is UK-resident, it is only where they are acquired pursuant to a “legal option” granted to the employee in a year when she was not UK-resident and not in respect of UK duties that 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 contrasting 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, ITEPA03/S22 or ITEPA03/S26, but the employee is within the charge to UK tax by virtue of ITEPA03/S27, 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)