Share options

There has been talk in recent weeks about share options granted to employees and the implications of tax paid at the higher rate of 46 per cent on any gains from these options. This was discussed particularly regarding the software industry where it was felt that many employees were leaving the Republic in search of better positions. In this context, the reduction of the rate at which gains on share options was charged from 46 per cent to 20 per cent would be seen as an incentive for many employees to stay here. Has there been any further discussion on this and what are the current tax implications on the disposal of share options?

Ms M.G., e-mail

As you say there has been a lot of talk about the issue of share options and their use as an incentive to employees. It is widely felt that in the current set-up, where income from such options is treated as income and taxed at the marginal rate, there is little incentive provided by such schemes.

The issue has arisen because of concerns about labour shortages in general and, in particular, in the software industry. This shortage of skilled labour has led to severe headaches for companies as rivals, desperate for staff, offer ever-higher remuneration. Not surprisingly, employees are opting to move to those companies offering the best deal at any particular time. This has sparked concern in Government and among economists about wage inflation in such sectors.

In this climate, the question of altering the position vis-a-vis the tax situation on share options has become topical. The argument is that a lower rate of tax on share options would encourage employees to remain loyal to their employer as the options are generally granted or exercisable in return for certain targets being met.

Proponents of change feel that a Government which saw fit to cut the capital gains tax rate from 40 per cent to 20 per cent on equities and certain other assets to encourage investment in the Irish market should allow a similar change in tax on share options to discourage employees from switching jobs regularly simply to reward the highest bidder. Doing so, proponents argue, would be one effective step in curbing wage inflation, which many see as the prime threat to the current economic buoyancy - the fear we may price ourselves out of the market.

Those opposed to such a move argue that introducing such a change would once again widen the gulf between the rich and the poor and would be an inappropriate loss of tax revenue in the context of social partnership.

Your reference to the fear of highly skilled labour travelling abroad is becoming an increasingly significant issue although the fact that the State is experiencing net immigration is reducing the impact.

There is a fear, however, that the highly mobile software companies, which are using the Republic as a base for European operations, may move on to cheaper labour markets if wages here become too high, despite the much-vaunted skill and flexibility of these sectors of the Irish workforce. For now the situation is unchanged. Share options are granted at a preferential rate. The tax liability occurs when the options are exercised and it amounts to the difference between the preferential price paid by the employee or director for the shares and the market price of the shares on the date the option is exercised and the shares purchased.

Let's say you have options on 1,000 shares in Company A at €5 (£3.94). The cost of buying the shares when you exercise the option is €5,000 (£3,938).

However, at the time you exercise the option, the shares are valued in the market at €10. Thus the real value of the shares you have just purchased via the option is €10,000 or £7,876. The difference between the two figures - in this case €5,000 or £3,938 - is liable to income tax at your marginal rate. There is a tax saving, however, in that PRSI is not levied on such payments.

The reason the whole sum is not liable is that you are exercising your option out of net income, that is income upon which you have already paid income tax.

Two other factors are worth bearing in mind. First, if the share options can be exercised more than seven years after they were granted, the Revenue will levy income tax at the time they were granted. This will be levied on the difference between the option price and the market price at the time. When the options are exercised, the tax you have already paid will be set against any liability due at the time.

The other is the issue of capital gains. Once you have exercised the option and bought the shares, you are liable for any capital gain on those shares after that date, provided it is in excess of the capital gains tax free allowance per individual of £1,000 in any one tax year.

While the situation is unchanged, it is certain that the Minister for Finance, Mr McCreevy, will come under sustained pressure in the run-up to the next Budget to alter it. You should also bear in mind that there are several other schemes designed to reward employee loyalty and operated by various companies. These include share incentive schemes and approved profitsharing schemes.

Please send your queries to Dominic Coyle, Q&A, The Irish Times, 11-15 D'Olier Street, Dublin 2 or e-mail to dcoyle@irish-times.ie. This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering queries. All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.