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What happens if an employee mistakenly treats a share option as liable to CGT?

9th August 2015

This type of problem seems to happen more frequently than it should. The taxpayer/advisor need not have been careless.

Some of the problems were discussed in Norman v HMRC [2015] UKFTT 303, which was heard and decided in June 2015. Other problems which the author has come across (to do with PAYE) are also mentioned below.

What happened in the Norman case

Mr Norman (the "taxpayer") was offered stock options when he joined a company as an employee. Two years later he left the company. At that point he exercised some of the options and immediately sold the shares.

The taxpayer relied on a transaction record provided by Citigroup, the sale agent, to complete his tax return. His return showed the gain on the sale of the shares as liable to capital gains tax ("CGT") and he paid tax accordingly. In fact the gain was liable to income tax, not CGT, because the options were "employment-related securities".

HMRC later made a discovery assessment to income tax. The taxpayer appealed to the First Tier Tribunal.

Was HMRC's discovery assessment valid?

Since the taxpayer had made a return in respect of the tax year, one of two conditions had to be satisfied for a discovery assessment to be made.

  • Either the taxpayer or his agent had to have been careless
  • Or, at the time when the window for enquiring into the tax return closed, the tax inspector could not have been reasonably expected to be aware that income which ought to have been assessed had not been assessed.

The Tribunal held that the discovery assessment was valid:

  • The taxpayer and his agent had not been careless because there was nothing to prompt them to treat the gain as liable to income tax.
  • On the other hand, the tax inspector could not reasonably have been expected to be aware of the problem on the basis of the taxpayer's return.

The taxpayer therefore owed HMRC a substantial amount by way of income tax - a good deal more than he had already paid by way of CGT.

How could the taxpayer recover the money that he had wrongly paid as CGT?

There was a further problem, however - namely that, as things stood, he was still liable to the CGT he had self-assessed and paid in respect of the same events.

The Tribunal discussed the possible ways of dealing with this in an Appendix to its decision. Briefly:

  • A taxpayer cannot appeal against his own self-assessment.
  • The time limit for amending a return and self-assessment had expired.
  • The Tribunal considered that it had no power to alter the amount of CGT payable by the taxpayer.
  • The taxpayer might be in a position to claim relief for overpaid tax under the Taxes Management Act 1970 ("TMA"), Schedule 1AB.
  • Failing that, the taxpayer would have to claim for the CGT self-assessment to be vacated under TMA, section 32.

This discussion was not necessary to decide the appeal but the list of options is helpful.

PAYE - not mentioned in the Norman case

In the author's experience, problems under the PAYE tax system can arise in this context. These were not mentioned in the Norman case. The issues include:

  • As already explained, the difference between the market value of the shares, when the employee acquires them under the option, and the price payable for them under the option counts as employment income for income tax purposes.
  • The employer has to account to HMRC for income tax on this employment income under the PAYE system. This liability arises as soon as the employee exercises the option, even if the employee does not sell the shares immediately but instead holds onto them.
  • Assuming that the employer cannot take the tax on the option gain from the employee's salary, the employee is then expected to pay the income tax back to the employer within 90 days after the end of the tax year in which the relevant date falls. If not, the sum that the employee does not make good to the employer by the deadline is treated as additional taxable income of the employee - on which the employee must pay extra tax.
  • If the system works correctly, therefore, the employer tells the employee about the income tax liability as soon as the option is exercised. The employee can then repay the tax to the employer within the time limit and can deal with everything correctly on his tax return.
  • If, on the other hand, the employer does not notice the PAYE issue and does not, therefore, alert the employee:
    • The employee unknowingly becomes liable to additional income tax.
    • The employee may incorrectly declare and pay a sum by way of CGT.
    • At some stage the employer is likely to have to pay a potentially large sum to HMRC, representing late payment of tax under the PAYE system. The employer may seek to recover at least part of this sum from the employee by way of restitution.
    • The employer and employee may then get embroiled in a heated dispute.
  • There are also National Insurance (social security) implications.

It is not clear from the Norman decision why these issues did not need to be considered in that case.


To summarise, therefore:

  • It is possible for both an employee and an agent who helps the employee with his/her tax return to make a mistake about the tax treatment of an option gain without either of them being careless.
  • Where an option gain has been treated as giving rise to a CGT liability and tax has been paid accordingly, it may not be easy to get the money back. (In practice, though, HMRC may not pay as much attention to the legal difficulties as the Tribunal did in the Norman case. They may simply offset the sum paid as CGT against the income liability without thinking too hard about whether they have power to do so. A taxpayer is unlikely to challenge this.)
  • In the author's experience, these problems have arisen where the employer has made a mistake. This can lead to additional tax liability. It can also lead to complex disputes between the employer and the employee as to how much liability for tax each of them should bear.

Important note: This is necessarily simplified. Tax law and practice can also change very quickly. Always take detailed, specific advice before taking, or deciding not to take, any action.

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