CIOT comments following the Mansworth v Jelley case, sent to the Inland Revenue on 24 January 2003.
You asked us to let you know the areas that were causing confusion following the issue of the Technical Note on Mansworth v Jelley. Your colleague, Michael Staples, suggested that you might deal with these in the form of Frequently Asked Questions on your website. We therefore detail below some questions that have been put to us and would be grateful if you were able to provide answers ideally as early as possible before 31 January 2003, which is obviously an important deadline for claimants.
If it is not possible to provide all the answers, it would be helpful if you could include as many as possible straightaway and then add the others later. As you will appreciate with the 31 January deadline approaching, some answers will be better than none!
We would expect that these are the types of questions to which the Revenue experts will already have given a lot of consideration, but, as well as drafting the questions in a form that could be used by taxpayers, we have provided some suggested answers and illustrative examples.
We would be very happy to either discuss the answers with you or to review the material you intend to put on the website beforehand. Of course, if there is any intention of mentioning the Chartered Institute of Taxation’s input in this initiative, we would like to see relevant copy before publication.
Suggested FAQs on Mansworth v Jelley Technical Note
1. Suggested question: Do those who acquire shares under an option need to differentiate between newly issued shares and other shares?
Suggested answer: No.
CIOT comment: The Inland Revenue statement of 8 January 2003 implies that, in the context of the option-holder, the Inland Revenue will not differentiate between newly issued shares and other shares. This has been orally confirmed by the Inland Revenue. It would be helpful if this were confirmed in writing.
2. Suggested question: Does the decision apply to shares acquired under an Inland Revenue approved share option plan where income tax was due on the exercise?
Suggested answer: Yes.
CIOT Comment: The Inland Revenue statement of 8 January 2003 implies that the new position will not apply to approved options exercised in an unapproved manner. However, s17 TCGA 1992 is only disapplied where no income tax is due (s185(3), (4) and (5) TA 1988). The fact that Mansworth does apply where income tax is due has been orally confirmed by the Inland Revenue. It would again be helpful if this were confirmed in writing.
3. Suggested question: What is the time limit for notifying losses or additional losses which arise as a result of the decision in Mansworth v Jelley, as interpreted by the Inland Revenue’s statement of 8 January 2003?
Suggested answer: For ITSA years (1996/97 onwards) losses must be notified by five years after the 31st January next following the year of assessment to which it relates. There is no time limit for notifying allowable capital losses for years before 1996/97.
CIOT comment: For example, under the new position, a loss for shares sold between 6 April 1996 and 5 April 1997 must be notified by 31 January 2003 to be an allowable capital loss. For later years, it will be 31 January five years after the end of the year of assessment (ie 31 January 2004 for 1997/98).
4. Suggested question: How do I notify capital losses?
Suggested answer: This would include what needs to be included in a claim for it to be valid.
5. Suggested example: Shares were sold in June 1998 and, under the old basis, a small gain was recognised on which capital gains tax was paid. Under the new position, a capital loss would have been recognised. Can that capital loss now be notified and the tax paid on the original gain repaid?
CIOT comment: The answer would cover the time limits for amending 2000/01 and 2001/02 returns as well as whether a s33 TMA “error or mistake” claim can be made.
6. Suggested example: Shares were sold in June 1998 and, under the old basis, no gain was returned as the sale proceeds and gain were less than the de minimis amounts. Under the new position, a capital loss would have been recognised. In September 1999, a capital gain arose on which capital gains tax was paid. Can the June 1998 loss be set against the September 1999 gain and the tax repaid?
CIOT comment: The answer would need to explain that the loss could be notified for use in later “open” years, but could only be used if the 1999/00 return was under enquiry.
7. Suggested question: How do I amend my 2001/02 tax return to use a capital loss?
CIOT comment: The guidance from CGN11 may be appropriate.
8. Suggested question: An individual (“A”) granted an employee (“E”) an option. A is subject to United Kingdom tax. A and E have both submitted their tax returns before 12 December 2002 but they are under enquiry by the Inland Revenue. If E amended her tax return to claim a capital loss, will the Inland Revenue change the tax return of A to recognise a capital claim?
Suggested answer: No.
9. Suggested question: T is a trustee of a United Kingdom resident employee trust. T granted employees’ options over shares with a very low exercise price (£1 in total) and these were exercised in June 2000 and June 2001. T did not submit a tax return for 2000/01 since the sales proceeds (under the old rules) were under the limits for reporting (T received around £200 of exercise monies in total but the shares were worth £100,000) and had no income to report. T had not intended to submit a tax return for 2001/02 on the same basis. If T had submitted a tax return by 12 December 2002, the Inland Revenue statement confirms that no amendment to the tax return is required. What is T’s position following the Inland Revenue statement?
CIOT comment: This is not covered by the Inland Revenue statement.
10. Suggested question: S was granted an option while on secondment to the US. S exercised his option when he came back to the UK. No UK tax was due on exercise but S did have some US tax to pay. Can you confirm that the base cost of S’s shares is their market value on the day that S exercised the option plus the amount of US tax that S paid?
CIOT comment: This question refers to s278 TCGA 1992.
11. Suggested question: R subscribed for shares on the exercise of an option in a small unquoted trading company and sold the shares on its takeover. R now has a capital loss on the sale of those shares. Can R make a claim to set the capital gain against her income?
Suggested answer: Yes, subject to the time limits for making such claims.
CIOT comment: This question refers to s574 TA 1988.
12. Suggested question: Q had lived and worked in the UK all his life. Q was seconded to work in Switzerland in May 2001 and became non-UK resident the day following his departure. In March 2002 Q exercised an unapproved option granted before Q left the UK, and immediately sold the shares. Q made no other disposals in 2001/02. Following the tax treaty apportionment practice outlined in Tax Bulletin 55, Q was charged Schedule E income tax on 80% of the exercise gain corresponding to prior UK service. Can Q now claim a capital loss? If so, how is this calculated?
CIOT comment: This is not covered by the Inland Revenue statement. Presumably the answer would be: Yes, subject to the time limits for making such claims. The amount of the loss would be based on the full amount of the option gain, not just the 80% subject to United Kingdom income tax.
Additional paper submitted
On 8 January 2003, the Inland Revenue announced their new policy in respect of share options following the Court of Appeal’s decision in Mansworth v Jelley. While we understand that background to the statement, we are concerned about the implications for the grantor of options. In particular, we are concerned with options granted by:
- United Kingdom resident employee trusts; and
- individuals subject to United Kingdom capital gains tax.
In these cases, the options were granted on the basis that the United Kingdom tax due would be based on the proceeds actually received on the exercise of the options (less base cost, taper relief and/or indexation). This is clearly stated in the Inland Revenue manuals and was not controversial. The Inland Revenue’s position has now been completely reversed, so that the tax is based on the market value of the shares on the exercise of the options. This will lead to considerable extra tax being paid.
Through the “grapevine”, we have heard about cases where the additional tax liability that some grantors may have to pay could run into many millions of pounds.
In the case of an employee trust, the extra tax due will normally be significantly more than the assets available to the trustees from the trusts, and this could mean that the trustee is personal liable for the excess (although in some cases there will be an indemnity from the company that original set up the trust). In the case of an individual having granted the option, it may lead to the individual’s bankruptcy.
We are pleased that the Inland Revenue have confirmed that any tax returns submitted before 12 December 2002 need not be amended. We should be grateful if you could confirm that where no tax return was submitted because, for example, the sale of the shares did not need to be reported under the then current rules, no tax liability will arise.
Although we are pleased that the Inland Revenue have protected the position for tax returns submitted by the 12 December 2002 deadline, we believe that this does not go far enough in this situation. We believe that the date chosen should relate to the date that the options were granted, rather than exercised or reported. This is because once the grant of the option has taken place, the exercise is beyond the control of the grantor.
We suggest that this could be done by extending the scope of ESC D35 to apply to:
- the exercise of options granted before 8 January 2003;
- Enterprise Management Incentive options (ie where no income tax is due on exercise); and
- individuals that granted options to employees.
Alternatively you could give a ruling that what you, and everyone else, thought were the correct rules (ie tax based on exercise price rather than deemed market value) will apply to the grantor on an option where the options were granted before 8 January 2003
Chartered Institute of Taxation
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