Tax implications of share option schemes: here’s what you need to know

Do you want to reward your team with share options? Great. Here’s what you need to know about tax on share options in the UK (and for your employees outside the UK).  In this article, we’ll cover both EMI and Unapproved schemes and how tax on options works on grant, exercise and sale. 

• EMI option schemes: tax implications for employees
• EMI option schemes: tax implications for companies
• Unapproved options schemes: tax implications for recipients
• Unapproved option schemes: tax implications for companies
• When to set up an option scheme
• How to set up an option scheme

EMI Option Schemes: Tax implications for employees

HMRC’s very popular EMI scheme allows tax advantages for both employees and companies that are eligible for the scheme.  The tax advantages of EMI options for employees include:

• No income tax or National Insurance Contributions (NIC) need to be paid when the options are granted
• If the employee exercises their options at the pre-agreed market value (AMV) with HMRC, they won’t need to pay Income Tax or NIC on exercise either
• If the employee has held their options or shares for at least two years before they sell them, the Capital Gains Tax they pay on sale will be reduced from 20% to 10%

Let’s take a closer look at the tax implications of EMI options for employees on exercise and sale. 

On exercise

If the exercise price of the options is the same or above the market value (AMV) agreed with HMRC when they were granted, the employee won’t owe Income Tax or NICs when options are exercised. 

If the employee was given a discount on the market value (AMV) agreed with HMRC, they’ll have to pay Income Tax (and in some circumstances, NICs) on the difference between what they paid and the market value of the shares at the time the options were granted. There’s more about this on the HMRC website. 

So if the employee owes Income Tax, how is the amount they owe calculated? This depends on whether the shares acquired are readily convertible assets or not (see box below for definition). 

• Where the shares acquired are readily convertible assets, the employee will owe Income Tax, which they’ll pay via PAYE
• If the shares are not readily convertible assets, the employee will be charged Income Tax on them via Self Assessment

On sale

When an employee sells their shares, they may have to pay Capital Gains Tax, which will be reduced from 20% to 10% if they have held the options or shares for at least 2 years.

Example:
Jessica is granted 10,000 share options and HMRC have agreed to an Actual Market Value (AMV) of £2 per share. However, she is granted the share options at a discount – a nominal value of £0.001 per share. In Jessica’s case, there will be two tax events.

Tax event 1

Five years after being granted options, Jessica exercises her options and, at this stage, the shares are worth £100,000. When she exercises her options, she will be taxed on the difference between £0.001 and £2:

10,000 shares at £0.001 per shares is £10 (what she paid)
10,000 shares x £2 per share = £20,000 (market value at the time of grant)
£20,000 – £10 = £19,990 is the amount Jessica needs to pay Income Tax on.

Tax event 2

Three years later, Jessica decides to sell the shares and they are now worth £150,000. She is liable to pay Capital Gains Tax of 10% on the difference between what she paid for the options (£10) and the new value of the shares (£150,000). Jessica would have to pay 10% Capital Gains Tax on £149,990.

If Jessica had been granted options at the market value at the time of grant (£2) she would not need to pay Income Tax on exercise. She would pay Capital Gains Tax when she sold the shares, though.

EMI Options: Tax implications for companies

With an EMI option scheme, your company can claim Corporation Tax relief when the employee sells the shares and when they exercise the shares (if those shares were granted at a discount).  

• If you grant an employee options at the market value (AMV), the Income Tax charge when they exercise the options is zero, so there is no Corporation Tax deduction in this scenario.
• If you grant an employee options at a discount, the Income Tax they pay is on the difference between the market value and the discount. Your company can claim Corporation Tax relief equal to the Income Tax amount the employee paid.
• If an employee sells the shares, they will pay Capital Gains Tax. Your company can claim a further Corporation Tax deduction equal to the amount of Capital Gains Tax the employee paid. 

Example:

In the example above when Jessica was granted options at a discounted price, she incurred an Income Tax charge on £19,990. She’d pay the tax charge according to her relevant tax bracket. Let’s say that tax charge was 20% of the total amount. Jessica would pay £3,998 towards Income Tax. This is the amount your company could then claim in Corporation Tax relief. The same would apply when she sells her shares and pays Capital Gains Tax – your company can deduct an equal amount of Corporation Tax to the Capital Gains Tax she paid.

Unapproved Options: Tax implications for recipients

Unapproved options can be given to people the EMI Scheme doesn’t cover. It’s a good way to give equity to contractors, consultants and team members abroad. The Unapproved scheme has fewer tax advantages than the EMI scheme, particularly for recipients. The only advantage is that tax is delayed until shares are exercised – your option holders don’t owe any tax when you grant their options. Some jurisdictions differ on this rule (such as Isle of Man, for example) so be sure to check the rule for your jurisdiction. 

The Income Tax and Capital Gains Tax recipients of Unapproved options will pay depends on their circumstances – in particular, where they’re located. Because you can grant Unapproved options to contractors and employees abroad, they will have to pay Income Tax according to the tax rules of where they are a tax resident. If you’re interested in granting options to employees abroad, read our article How to give share options to your overseas employees. 

Income Tax for Unapproved Options (UK)
When the recipient of a grant from an Unapproved scheme decides to exercise their options, HMRC charges them Income Tax on what they consider to be profit: the difference between the (lower) strike price of the options and the market value (higher) of the shares. The recipient will need to pay this by Self Assessment rather than PAYE.

Capital Gains Tax for Unapproved Options (UK)
Assuming the value of your company goes up after your employee has exercised their options and when the employee sells their shares, they’ll pay full Capital Gains Tax on the profit (the difference between the amount the shares were worth when they exercised, and when they sold them).

Unapproved Options: Tax implications for companies

With an Unapproved Scheme, when an employee exercises their options, your company is liable for an Employer’s National Insurance Contribution (NIC) if the shares the employee acquires are a ‘readily convertible asset’ (see box above).

For holders of Unapproved options who are on your company payroll, your company can claim a Corporation Tax deduction equal to the Income Tax charge of the option holder (the difference between the market value of the shares at exercise and what the employee pays for them).

When to set up a share option scheme

After helping thousands of companies set up their share option schemes, we’ve seen that there are two optimal times to set up a scheme:

1. Raising funds

Set up your scheme before a funding round to become more attractive to investors. You might want to consider getting your EMI valuation at least three months before you start to fundraise so that you can get a low strike price for your future employees.

2. Growing your team

If you have your options scheme in place before you hire, you can highlight this perk to attract job-seekers.

Learn more about the optimal times to set up your scheme in our article: When is the right time to put your EMI scheme in place?

How to set up a share options scheme

You can set up an option scheme through lawyers or accountants who’ll do it for you, or you can use SeedLegals to set up your scheme online.

We combine automation with unlimited help from share option scheme experts. You can easily set up your scheme in minutes on SeedLegals using our guided workflow, and if you need some help, our experts are just a call, instant message or email away.

Set up a share option scheme with SeedLegals: how it works

• Create your option pool
• Create your option scheme
• Choose vesting and exercise rules
• Pass a board resolution to adopt the option scheme
• Grant the options
• Enter the details of your team members and the option grants
• Send out the option agreements to your team to sign

To get started, log in or register and go to Share Options. There’s built-in guidance but if you need any help, hit the chat button to message our experts.

Talk to an expert

Still got questions? Get them answered fast by booking a call with one of our share option scheme experts: