Finance Bill 2002: EXPLANATORY NOTE
CLAUSE 49: SHARES ACQUIRED ON SAME DAY: ELECTION FOR ALTERNATIVE TREATMENT
SUMMARY
1. This clause amends the capital gains tax (CGT) rules for identifying which shares have been disposed of when there is a part disposal of a holding of shares. It provides an alternative ordering rule for matching disposals with acquisitions where an individual has acquired shares by different transactions on the same day and some of the shares were acquired through an employee share scheme. The alternative rules apply only where the individual elects for them to do so.
DETAILS OF THE CLAUSE
2. Subsection (1) introduces sections 105A and 106B into the Taxation of Chargeable Gains Act 1992 (TCGA). The effects of these provisions are described in paragraphs 5 to 23 below.
3. Subsection (2) provides for these sections to take effect for shares acquired on or after 6 April 2002.
4. Subsections (3) and (4) make special provision for commencement where shares to which relief under the Enterprise Investment Scheme (EIS) is attributable have been transferred between husband and wife. In such cases, the person to whom the shares were transferred is treated as having acquired the shares on the day they were issued. This ensures consistency with the special rules which apply for disposals of EIS shares.
Section 105A TCGA
5. Subsection (1) set outs the circumstances in which the alternative ordering rule can apply. First, an individual, acting in the same capacity, must have acquired shares of the same class in a company on the same day. These shares are called ?the relevant shares? in sections 105A and 105B.
6. Second, the individual must have acquired some of the relevant shares ?
- either by exercising an option under the Enterprise Management Incentive scheme without incurring any income tax charge when the option was exercised,
- or by exercising an option under an approved share option scheme without incurring any income tax charge when the option was exercised.
Those of the relevant shares which have been acquired in either of these ways are called ?the approved-scheme shares? in sections 105A and 105B.
7. Subsection (2) provides for such an individual who has made a disposal of any of the relevant shares to elect for the alternative ordering rule to apply. The election applies to all the relevant shares. If an election is made it applies to the first and all subsequent disposals of the shares subject to the election. An election can apply only in respect of shares acquired on the date in question.
8. Subsections (3) to (5) set out the alternative identification rules which apply if an election is made. Subsection (3) is the prime provision. It modifies the normal rule for shares acquired on the same day in two ways. (The normal rule in section 105(1) TCGA treats all shares acquired on one day as if they were acquired in one transaction.) First, the shares acquired on the day in question are divided into two groups, the approved-scheme shares and the remainder. Second, the shares in the ?remainder group? are treated as disposed of before any of the approved-scheme shares. (In the paragraphs below, shares in the ?remainder group? are referred to as ?other? shares).
9. The principal effect of these two modifications is that the chargeable gains arising on the first occasion when some of the relevant shares are disposed of are less than they would be under the normal rule. This is because the alternative rule identifies the shares disposed of as being shares other than the approved-scheme shares as far as this is possible, and shares which are not approved-scheme shares will have a higher acquisition cost for CGT purposes.
10. Subsection (4) adapts the new ordering rule to shares which are subject to the special EIS identification rules. The EIS rules already provide for shares acquired on the same day to be put into different categories and treated as disposed of in a particular order. Subsection (4) ensures that these EIS rules are not displaced. But, if there are approved-scheme shares and ?other? shares in any particular category, the ?other? shares will be treated as disposed of before the approved-scheme shares.
11. Subsection (5) provides a streaming rule which preserves the distinction between the approved-scheme shares and the ?other? shares where a restructuring of the company takes place and it affects the shares for which an election has been made. For CGT purposes, the shares or securities which a person holds after a restructuring are treated as the same asset as those held before if certain conditions are met. Subsection (5) ensures that the shares or securities held after the restructuring are split proportionately into two categories which respectively represent the approved-scheme shares and the ?other? shares for the purpose of applying the ordering rules in subsections (3) and (4).
12. Subsection (6) provides interpretation for subsection (5).
13. Subsection (7) makes special provision for the purposes of subsection (1) where shares to which EIS relief is attributable have been transferred between husband and wife. In such cases, the person to whom the shares were transferred is treated as having acquired the shares on the date they were issued. This ensures consistency with the special rules which apply for disposals of EIS shares.
14. Subsection (8) provides interpretation.
Section 105B TCGA
15. Section 105B supplements section 105A.
16. Subsection (1) provides that the identification rule in section 105A overrules any other way of identifying the shares which an individual has disposed of.
17. Subsection (2) gives the time limit for making an election - one year ten months after the end of the tax year in which the first part disposal takes place. If, for example, the first part disposal falls in the tax year 2002-03, the election must be made no later than 31 January 2005.
18. Subsection (3) applies where some of the shares an individual acquired as an employee were subject to restrictions on his or her right to dispose of them and the restrictions are lifted. While the restrictions apply, these ?restricted shares? are treated for certain CGT purposes as being of a different class from that to which they actually belong. Once the restrictions are lifted, subsection (3) brings these shares within the scope of an election made by the individual in respect of shares of that class acquired in the same capacity on the same day.
19. Subsection (4) modifies the time limit for the election in certain special circumstances. For CGT purposes, the receipt of a capital distribution from a company by a shareholder is treated as a part disposal of the shares concerned, as is the receipt of cash under the terms of a restructuring of the company in certain circumstances. Such part disposals of shares by an individual are ignored in establishing whether an individual has made a first disposal of some of the shares acquired on the particular day. The individual's right to decide whether to elect or not is therefore preserved until a disposal is made on which an election would have an effect.
20. Subsection (5) prevents an election being made in respect of ordinary shares in a venture capital trust (VCT).
21. Subsection (6) gives the words 'same class? their normal TCGA meaning - stock exchange practice is followed.
22. Subsection (7) provides interpretation where a company restructuring takes place and the streaming rule operates (see paragraph 11 above).
23. Subsection (8) provides definitions.
BACKGROUND NOTE
24. The current CGT rules treat shares of the same class, acquired on the same day by a person acting in the same capacity, as having been acquired in a single transaction. This treatment has the effect of pooling all the acquisitions and averaging out the total cost over all the shares.
25. Clause 49 allows an individual to elect instead to treat shares which carry a higher CGT cost as disposed of in priority to those with a lower cost.
26. The following example illustrates the difference an election can make.
Example
On 30.11.02 an employee acquires ?
-
2,400 shares under an approved share option scheme, and
-
1,000 shares under an unapproved share option scheme.
The actual cost of the shares is £6 per share. But for CGT purposes the cost of the unapproved shares is effectively based on their market value, which is £12 per share. The employee therefore acquires ?
-
2,400 ?approved-scheme shares? with a CGT cost £14,400, and
-
1,000 ?other? shares with a CGT cost £12,000.
Exercising the unapproved option makes the employee liable to an income tax charge. To meet the liability the employee sells 200 shares @ £12 per share, realising £2,400.
If the employee does not make the election, the 200 shares disposed are matched with 200 of the total 3,400 pooled shares, and a chargeable gain arises, calculated as follows:
| Consideration received |
= £2,400 |
||
| Total cost of all shares:- | |||
| 2,400 | cost £14,400 | ||
|
plus |
1,000 | cost £12,000 | |
|
Total |
3,400 | cost £26,400 | |
| Cost of shares sold ((200/3,400) × £26,400) Chargeable gain (ignoring incidental costs) |
= £1,553 |
||
If the employee makes the election, the 200 shares disposed of are matched with 200 of the 1,000 ?other? shares, and no chargeable gain arises: the calculation is as follows ?
| Consideration received | = £2,400 |
| Cost of shares sold ((200/1,000) × £12,000) | = £2,400 |
| Chargeable gain (ignoring incidental costs) | = £ nil |