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

Key facts to know for context:

• Share options are granted or issued when the terms are written up in a share option agreement, which is signed by the employee and company – they are only share options at this point
• Shares are exercised when the employee pays the pre-agreed share price for each of their share options – at this point they are no longer share options, they are now shares
• Shares are sold when a buyer purchases them – the shares now belong to a new shareholder

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 usually 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. 

If the employee is terminated

If an employee is terminated by a company, the tax implications of their share options will depend on when they exercise the options:

• If they exercise the share options within 90 days, they’re entitled to the tax advantages of the EMI scheme, and the tax events shown in the examples below will apply
• If they exercise the share options after 90 days, the tax advantages associated with EMI won’t apply. They’ll be taxed as if they’re unapproved options

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 and qualify for Business Asset Disposal Relief.

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 what she paid, £0.001 and the market value at the time of grant, £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.

*Income Tax is paid at 20% for basic rate tax payers, 40% for higher rate, 45% for additional rate + NIC.

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 the full market value at the date of grant (£20,000) and the new value of the options (£150,000). Jessica would have to pay 10% Capital Gains Tax on £130,000 (which is £13,000 in tax).

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 on the difference between £150,000 and £20,000 (so 10% on £130,000) when she sold the shares, though.

EMI Options: Tax implications for companies

Taxes the company needs to pay

As a company, you don’t need to pay tax on EMI schemes:

• You won’t have to pay tax when EMI options are granted, exercised or sold
• The exercise price you set has no effect on the tax due (as there is none) or the deductions you can claim – so there is no tax benefit or drawback if you offer an exercise price that’s lower than the EMI valuation price
• The only tax charge on EMI shares is for the employee holding the shares, when they sell the shares for a profit. If the value goes down there will be no tax charge on the employee as there will not be any income gained
• You might have to pay NIC (which is actually a social security, not a tax). However, you don’t have to pay NIC if you sign an s431 election. Read S431 and NIC tax elections: what are these forms for share option holders?

Tax deductions the company can claim

With an EMI option scheme, your company can claim Corporation Tax relief when the employee exercises the share options and sells their shares (even 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 gain made by the employee.

Here’s an example:

If share options were issued at a discount (£0.001 per share), Corporation Tax deduction would be worked out like this:

If the market value at exercise was £100,000, you’d subtract £10 (the price paid for the shares), which is £99,990. This £99,990 is tax deductible for the company, which at 19% corporation tax works out to £18,992 in tax savings for the company.

If share options were not issued at a discount and £2 were paid per share for 10,000 shares, for example, the Corporation Tax deduction would be worked out like this:

If the market value at exercise was £100,000, you’d subtract £20,000 (the price paid for the shares), which is £80,000. This £80,000 is tax deductible for the company, which at 19% corporation tax works out to £15,200 in tax savings for the company.
These tax deductions can be claimed during the accounting period in which the exercise takes place.

Unapproved Options: Tax implications for recipient

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 at exercise. 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 should be able to 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: