Unapproved Share Option Schemes - CGT

Unapproved Share Option Schemes Mansworth v Jelley

For Capital Gains Tax purposes the allowable cost of shares that have been issued to an individual under an unapproved share option scheme has been, under current interpretation, the sum of the following:

• The cost (if any) of the option (Section 540(4)) ¹;
• The price paid for shares on exercise of the option (Section 552(1)) ²; and
• The amount charged to income tax on the exercise of the option (Section 128).

This interpretation has been published in Tax Briefings 31 and 40.

The decision of the UK Court of Appeal in the case of Mansworth v Jelley ([2003] STC 53) has raised doubts about our current interpretation.

Mansworth v Jelley

The Mansworth v Jelley case was concerned with the allowable cost for CGT purposes of shares acquired on the exercise of an option that had been granted to the taxpayer concerned by reason of his employment. The option was granted when the taxpayer was not UK resident and exercised when the taxpayer was UK resident. The shares in question were shares already in existence i.e. they were not newly issued shares. On acquiring the shares the taxpayer immediately sold them on.

HM Revenue and Customs raised capital gains assessments on the taxpayer on the basis that the allowable cost of the shares was the sum of:

• The market value of the option at the time of grant; and
• The price paid for the shares on exercise of the option.

Under UK practice the taxpayer was not liable to an income tax charge on exercise of the option since it had been granted at a time when he was not resident. Since it was agreed that the option was granted in consideration of the taxpayer's services in his employment the market value of the option replaced its actual cost under the UK equivalent of our Section 547(1)(c)(iii). In any event, in this case both the cost of the option and its market value were nil.

However the UK Court of Appeal determined that the allowable cost of the shares to be used in the computation of gain on their disposal was their market value at their time of acquisition - the value (if any) of the acquisition of the option was irrelevant. This meant that the taxpayer had no gain on disposal of the shares since the shares were disposed of immediately after their acquisition on exercise of the option. In brief, the Court's reasoning was that the transaction under which the taxpayer had acquired the shares was a single transaction comprising both the acquisition of the option and its exercise and that that single transaction was an acquisition by reason of the taxpayer's employment. Therefore, the market value rule applied since as the shares were not newly issued shares the equivalent of our Section 547(3) was not relevant.

Revenue’s View

Having considered Mansworth v Jelley, Revenue does not propose to treat the amount charged to income tax as part of the cost of acquiring the shares. The base cost, for capital gains tax purposes, of shares acquired on the exercise of an option under an unapproved share scheme should be calculated as follows:

Where the shares are issued on the exercise of the option:

Regardless of when the options were exercise the cost of acquisition is the sum of the following:

• The cost (if any) of the option
• The price paid for shares on exercise of the option and
• The amount charged to income tax on the exercise of the option.

Where the shares are already in existence at the time of exercise of the option:

For options exercised before 12/12/2002 the cost of acquisition is the sum of the following:

• The cost (if any) of the option,
• The price paid for shares on exercise of the option, and
• The amount charged to income tax on the exercise of the option.

For options exercised on or after 12/12/2002 the cost of acquisition is the market value of the shares at the time of exercise.

There is no question of adding the amount charged to income tax to the market value of the shares.

Summary

In effect the method of calculating costs of acquisition set out in Tax Briefing 31 continues to apply to all unapproved share option schemes with the exception of options exercised on or after 12/12/2002 where the shares were already in existence at the time of exercise of the option.