On 12 May 2009 HM Revenue & Customs (HMRC) published revised guidance on its interpretation of the decision in Mansworth v Jelley. This affects allowable deductions for capital gains tax (CGT) purposes for shares acquired prior to 10 April 2003 on the exercise of unapproved share options, Enterprise Management Incentive options and approved options exercised in an unapproved manner.
Following the decision in Mansworth v Jelley, HMRC published guidance in 2003 on calculating the CGT base cost of shares acquired on the exercise of unapproved options. This provided that the base cost would be (i) the market value of the shares acquired on the date the option was exercised plus (ii) the amount on which the employee paid income tax. This guidance was favourable to employees as it provided them with an uplift in the base cost of such shares which either gave rise to a capital loss, or reduced the amount of capital gain arising, on a subsequent disposal of those shares.
The Taxation of Capital Gains Tax Act 1992 was then amended with effect from 10 April 2003 to provide that the base cost of shares acquired on the exercise of unapproved options would be the consideration paid by the employee in respect of the grant and exercise of the option (rather than the market value of the shares).
HMRC has stated that it has now received legal advice that the guidance published in 2003 was wrong. Under the revised guidance the base cost of shares acquired on the exercise of unapproved options no longer includes the amount on which the employee paid income tax – so the base cost is only the market value of the shares acquired on the date the option was exercised.
Impact of revised guidance
This change is likely to have an impact on employees who acquired shares on the exercise of unapproved options prior to 10 April 2003 and either (i) still hold those shares or (ii) have disposed of those shares in a tax year for which their tax return has not yet been made or for which the return remains open.
Employees who still hold shares acquired on the exercise of unapproved options prior to 10 April 2003 will be required to apply the revised guidance at the time they sell those shares and so will not be able to take advantage of the uplift in base cost that was provided by the previous guidance.
The revised guidance suggests that HMRC’s view is that affected employees “may need to” make or amend their tax return, and states that HMRC will apply the revised guidance where there is an open enquiry or appeal.
Employees who have already sold the shares and claimed a capital loss (and whose tax returns cannot be reopened or subjected to an enquiry) will not be affected.
The following employees will be affected by this change:
- An employee who has disposed of the shares but has not yet filed a return will be required to file the return on the basis of the revised guidance.
- Where a return has already been made on the basis of the original guidance but the return remains open, the employee will need to consider whether that return should be amended.
- Where a return is subject to an enquiry or appeal in relation to a separate point HMRC may, as part of that enquiry or appeal, adjust the amount of CGT due in that tax year by applying the revised guidance. Employees should consider this risk when deciding whether to make an “error or mistake” claim to correct overpaid tax for a tax year in which CGT liabilities were calculated on the basis of the original guidance as HMRC may, as well as dealing with the overpayment raised by the employee, adjust those CGT liabilities in line with the revised guidance.
- It is not clear from the revised guidance whether an employee who has disposed of shares but not yet utilised any carried forward losses is prejudiced. Pending clarification by HMRC there is a risk that, as the utilisation of carried forward losses will be reported in the return for a year in which the revised guidance applies, HMRC will seek to apply the revised guidance to those losses.
HMRC has not published the legal advice on which the revised guidance is based, so it is not possible to determine whether it could be subject to challenge (although it is worth noting that many commentators felt the original guidance was surprising but it was not challenged as it was favourable to taxpayers).
In addition to technical grounds for challenging some aspects of HMRC’s revised approach, issues of fairness arise as the application of the revised guidance hinges on the disposal date of the shares (and possibly on the utilisation date of any carried forward losses).