Granting Shares Options to non-employees/Consultants

By nature of their contract for services, consultants are not eligible for any of the approved tax advantaged share option schemes in the same way that employees of a company offering incentives are. Approved share option schemes include:

• Enterprise Management Incentive Options (EMI scheme)
• Company Share Option Plan (CSOP)
• Share Incentive Plan (SIP)
• Save As You Earn (SAYE)

Unapproved share options are still a cost-effective way of incentivizing both employees (in the case of a company that does not qualify for any of the approved schemes) and as a form of consideration for consultants.

The tax effect of unapproved share options granted to employees is as follows:

• There is no tax effect on the grant of the options.
• On exercise, the share options are subject to income tax on the market value of the shares less any amount actually paid by the employee. If there is an open market to sell the shares, they will be considered readily convertible assets and, as such, will be subject to class 1 national insurance. Both income tax and NICs will be collected via PAYE.
• The amount on which tax is paid is added to the employee’s acquisition cost for capital gains tax purposes. Effectively, this makes the base cost equal to the market value of the exercise.
• On disposal of the shares, the employee will be subject to any capital growth from the date of exercise.

Usually, options are exercised by employees when there is an open market to sell the shares. This is due to the sum of income tax and NICs being costly as they commonly exceed the employee’s salary, leaving the employee with insufficient cash reserves to cover the taxes due on exercise. This also means the employee is unlikely to have benefited from much capital growth.

The tax implications of granting share options to a consultant (non-employee) are slightly different, and while there is currently no case law nor legislation in place, the case of Abbott v. Philbin is considered authority, and the tax implications are as follows:

• On grant, the options are effectively consideration paid for the services provided by the consultant and, as such, are subject to income tax based on the market value at grant. No class 1 NICs will be due as the consultant falls outside the scope of employment taxes.
• Unlike share options granted to employees, the amount on which income tax is incurred by the consultant on the grant of the options does not affect the base cost in any way. The base cost is merely the value of the options at the date of grant.
• On future exercise of the options, there are no further income tax implications for the consultant.
• On disposal, as with employees, the consultant will be subject to capital gains tax on any capital growth of the options from the date of grant. Business asset disposal relief will not be available to the consultant (where it may have been in the case of an employee) due to the lack of employment status.

From a VAT perspective, if the shares have been given in payment or part payment for the services provided to the company by the consultant, then the provision of the shares to the consultant is consideration in kind in return for the services the consultant has provided, and so the supplies provided by the consultant are subject to VAT at the appropriate rate. For the company issuing the shares to the consultant in payment for his services, the issuing of shares is generally a VAT exempt activity. The only time this is not the case is when the shares are issued in order to raise funds for the company, in which case the issuing of the shares is not a supply for VAT purposes and so is outside the scope of VAT.