Finance Bill 2003 - Implications for Unapproved Share Options
by Sheila Dowling
INCOME TAX DEFERRAL
Under the current tax code employees granted share options are generally liable to income tax on the exercise of the option. An income tax charge arises on the difference between the market value of the shares at date of exercise and the option price paid by the employee. However, individuals could elect to defer the payment of the income tax liability until the shares are sold or for a period of seven years, whichever is earlier. The 2003 Finance Bill provides for the abolition, from the date of enactment of the Finance Bill, of the right to elect to defer the payment of income tax. Elections made prior to enactment are still valid.
The 2003 Finance Bill is due to be enacted later this month so there remains a short window period within which share options can be exercised and an election made to defer the payment of income tax for up to seven years. Any individuals with unexercised vested options should immediately review their position to see whether there is any benefit in exercising their option prior to the enactment of the Finance Bill.
ACCELERATED INCOME TAX PAYMENT DATES
There is no change to the method in which share option gains are calculated. Such gains will continue to be calculated on the difference between the market value of the shares on exercise and the option price paid by the employee, however the tax payment date has been accelerated.
Share Options exercised from 1 January 2003 to 29 June 2003
Income tax on share options exercised prior to 30 June 2003 is payable by 31 October 2004 subject to preliminary tax obligations being met in 2003. If the option is exercised prior to the date of enactment of the Finance Bill it is possible to elect to defer the income tax payment for up to 7 years from the end of the 2003 tax year, assuming the shares are retained until at least 1 January 2004. This election must be made by 31 October 2004. An early disposal will crystallise the deferred income tax liability.
Share Options exercised on or after 30 June 2003
Individuals who exercise share options on or after 30 June 2003, will be liable to pay the income tax due to the Collector General within 30 days of the option being exercised irrespective of whether these shares are disposed of or retained. A return, in a format yet to be prescribed by the Revenue Commissioners must be filed by the individual with the relevant income tax payment.
Tax at the marginal rate (currently 42%) must be paid in respect of the option gain. However, where an individual satisfies the Revenue Commissioners that he/she is liable to income tax at the standard rate only, then the standard rate can be applied to the gain in determining the tax liability. It is important to note that the onus is on the individual to seek advance clearance that the standard rate of tax applies.
The above amendment significantly accelerates the payment date for income tax on share options and could result in cash flow difficulties for individuals. Failure to pay the income tax by the due date carries an interest exposure of 0.0322% per day from the due date.
‘UNDERWATER’ SHARES
In recent years, due to the downturn in equity markets, many individuals have faced income tax liabilities in excess of the market value of the shares acquired by exercising share options. The Finance Bill introduces a provision to deal with situations where individuals, having exercised share options before 6 February 2003 have incurred an income tax liability that exceeds the market value of these shares. This provision will ensure that individuals in such a position can elect to make a payment on account equivalent to the market value of those shares.
The following conditions apply: -
-the provisions only apply to share options exercised before 6 February 2003
- the income tax arising on the exercise must exceed the market value of the shares at the “valuation” date. The valuation date will depend on whether an election to defer the payment of income tax was made (refer to table below)
-an election must be made by the individual in writing to the Revenue Commissioners (in a yet to be prescribed form) on or before 1 June 2003. This form must contain details of the date of exercise, the number of shares acquired, the market value of the shares at the date of exercise and any other information to be specified by the Revenue Commissioners.
Underwater Shares - Income Tax Payment on Account
The following table illustrates the valuation date for market value purposes and the payment on account due date for under-water option shares in respect of share options exercised before 6 February 2003.
In each of the following circumstances an election must be made by 1 June 2003 for a payment on account of income tax to apply.
|
Election for 7 year deferral |
Valuation Date |
Payment on account due date |
|
No deferral election made and income tax outstanding
|
(i) 6 February 2003, or
(ii) date of disposal if earlier |
On or before 30 June 2003 |
|
Election for deferral made and early disposal |
Date of disposal |
(i) 30 days after date of disposal or, if later
(ii) 30 June 2003 |
|
Election for deferral made and retention of shares for 7 years |
31 December at end of 7 year deferral period |
30 days from end of deferral period (i.e. 30 January) |
|
Entitlement to elect for deferral is not made for 2002 exercises and/or 2003 exercises (up to 6 February 2003) |
(i) 31 October 2003 (in respect of a 2002 exercise), or
(ii) 31 October 2004 (in respect of a 2003 exercise up to 6 February 2003) |
(i) 30 November 2003 (in respect of 2002 exercise), or
(ii) 30 November 2004 (in respect of 2003 exercise up to 6 February 2003) |
BALANCE OF INCOME TAX DUE
Where an individual chooses to make a payment on account under any of the circumstances outlined above and any shares (whether option shares or not) are disposed of at a profit, a balance of income tax will be due by 31 October in the tax year following the year of disposal. However, where an individual elected to defer the income tax liability on exercise and still retains these shares, the balance of income tax will not be due until 30 days from the end of the deferral period i.e. 30 January 2011 where options are exercise in the period 1 January 2003 and before 6 February 2003.
In certain circumstances the balance of income tax payable may be restricted. This will apply where there is a subsequent disposal of any shares and a balancing payment of income tax remains outstanding. The balancing income tax payment crystallising on the subsequent disposal of any shares will be the lower of:
-(i) the balance of unpaid income tax and
-(ii) the chargeable gain less any income tax paid on the share option exercise (where applicable) and capital gains tax payable on the actual disposal.
Please note that any loss arising on the sale of under water shares will not be available for offset against capital gains until the balance of any income tax liability arising on exercise has been discharged.
For further information, please contact sheila.dowling@ie.ey.com
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