How are consultants taxed on share options?
22nd December 2023
Posted in Articles by Andrew Marr
Rumour has it that when Facebook’s first office needed painting the company did not have enough money to pay the decorator. Instead of paying him the $60,000 fee, they gave him shares in the company. When the company listed in 2005 his shares were worth around $200 million!
The tax implications of offering shares to employees are fairly well understood, but what if the individual (like the Facebook decorator) is not an employee?
Tax rules for employees
Under employment-related securities (‘ERS’) rules, employees who receive shares under non-HMRC approved schemes are chargeable to income tax on the difference between the market value of the shares and the amount paid for them. National Insurance is also payable if the shares are readily convertible assets (‘RCAs’).
Some companies operate share option schemes, where the employee is given the right to acquire shares in the future (say if the company is sold). In this case, there is no tax at the point the share option is granted. However, income tax is payable at the point the option is exercised on the difference between the market value of the shares and the option price (this is similar to the rule above). National Insurance is also payable if the shares are RCAs.
There are different rules for “approved” schemes – such as EMI and CSOP – which are outside the scope of this Tax Bite.
But what about consultants?
As the name implies, ERS rules are only applicable where the opportunity to acquire the shares arises from a person’s employment (which for these purposes includes being a director). Consequently, if a person is not an employee or director (for example they are a consultant) then these rules do not apply. However, there will probably still be tax implications.
Returning to the Facebook example (and assuming that it all happened in the UK!), if the decorator had received his fee in cash, he would have been assessable to income tax on the money as income from his sole trade. The receipt of non-monetary consideration is taxed in the same way if the asset is the payment is ‘money’s worth’. Case law has determined that shares and share options can be ‘money’s worth’. Consequently, the sole trader should assess himself to income tax on the value of what they receive (probably $60,000 in the above example).
Share options
Valuing share options can be more complicated, but the same principle applies – the consultant is taxed on the value of the option at the date it is granted. However, that is then the end of the matter as far as income tax goes. If the option is later exercised, even if the shares have increased in value, there is no further income tax to pay (based on the decision of the House of Lords in the case of Abbott v Philbin).
This means that when the shares are later sold any profit is subject to capital gains tax. Here, the base cost will be the amount paid to acquire the shares either in money or money’s worth. This would include the market value that was assessed to income tax at the date that the shares or share option was received (but not the tax paid).
VAT
The value of supplies that are made in return for non-monetary consideration are deemed to be VAT-inclusive (where a supply is subject to VAT). In other words, the value of the supply is deemed to be the amount in money which, when added to the VAT, equals the amount that would have been given if payment was made in money. Consequently, if the decorator’s $60,000 fee was VAT-inclusive then he would still have to account to HMRC for the VAT, even though he did not receive this in cash.
Forbes Dawson view
We are seeing lots of queries on this type of issue, which suggests that it is fairly common practice. This should be attractive to consultants from a tax perspective because any eventual uplift in value will be subject to capital gains tax rather than income tax. This is in direct contrast to the normal rules for employees, although the bad news is that the company would not benefit from a corporation tax deduction for any profit realised by the consultant (unlike the case for employee share rewards).
