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Option Schemes Aug 19, 2021 4 min read

So you want to grant options? Here are the tax implications

You want to grant your team options? Great! Here are a few things to consider before you get started:

Which type of option scheme should I set up? 

Broadly, there are two types of option scheme that UK startups and small businesses can use:

  • EMI Option Scheme
    This is for PAYE employees only.
  • Unapproved Option Scheme
    You can use an unapproved scheme for staff not on PAYE: consultants, advisors and other collaborators.

The EMI (Enterprise Management Incentive) Option Scheme is a generous way to reward employees with equity in your company. And it’s popular: of all the companies who operate tax-advantaged option schemes, 87% have an EMI Scheme (source: HMRC).

It’s possible for a company to operate more than one type of option scheme but most companies who give share options only have one scheme. In the tax year ending 2020, 99% of companies operating an EMI scheme did not operate any other tax advantaged schemes (source: HMRC).

In practice, the main difference between EMI and Unapproved Option Schemes is that for EMI, HMRC will approve a valuation for your company and fix a ‘strike price’: the price at which options can be ‘exercised’.  The aim is to get a super-low EMI valuation – much lower than your actual company valuation – so your employees get a bigger financial gain when they exercise. (We explain ‘exercising’ below.) To operate an EMI Scheme, you’ll need to meet the qualifying conditions.

For an Unapproved Option Scheme, a company normally sets the strike price so when an employee exercises their options, they pay nothing or only a nominal low price for each share.

Read more:
Which is best for your company – EMI or Unapproved Share Options?

EMI Option Scheme: What are the tax implications for employees?

Your employees won’t have to make a tax payment when you grant options to them, or when they ‘exercise’ the options. Exercising share options is when the employee buys the shares at the agreed strike price.

Employees only pay tax when they then sell the shares. This is normally when there’s an IPO (Initial Public Offering) or the company is sold.

With an EMI scheme, when your employees sell their shares, they pay only 10% Capital Gains Tax on any profits. This is one reason why giving share options is better than giving shares to your team: the tax implications are lower.

EMI Option Scheme: What are the tax implications for my company?

With an EMI Option Scheme, when your employee exercises their options, there’s no Employer’s National Insurance Contribution to pay, and your company can claim a Corporation Tax (CT) deduction equal to the financial gain of your employee. (This gain is the difference between the market value of the shares at exercise and what the employee pays for them.)

If you’ve granted options at a discount, this CT relief could be a significant amount.

Unapproved Option Scheme: What are the tax implications for employees?

Your employees won’t have to make a tax payment when you grant options to them.

  • Income Tax
    When your employee 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 employee will need to pay this by Self-Assessment rather than PAYE.
  • Capital Gains Tax (CGT)
    Assuming the value of your company goes up after your employee has exercised their options, when the employee sells their shares, they’ll pay full CGT on the profit (the difference between the amount the shares were worth when they exercised, and when they sold them).

The rate of Income Tax and CGT your employee will pay depends on their circumstances. It’s sensible to remind your employees to seek qualified tax advice before they exercise options or sell shares.

Unapproved Option Scheme: what are the tax implications for my company?

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’ (RCA).

An RCA is a type of asset that’s treated as if it were cash for calculating income tax. The shares are only considered to be ‘readily convertible’ if your company is public, or about to be sold with an arrangement to buy the shares.

When your employee exercises their options, your company can claim a Corporation Tax (CT) deduction equal to the financial gain of your employee (the difference between the market value of the shares at exercise and what the employee pays for them).

SeedLegals | Option Schemes

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When is the right time to start an option Scheme?

At SeedLegals, we’ve helped thousands of companies set up and manage their option scheme. We believe the right time to start an option scheme is when your company is doing one or more of these:

  • Gaining traction
    When your company is financially sustainable and starting to scale up..
  • Fundraising
    When you’re getting ready for investment but before you’ve formally started a fundraising round.
  • Growing your team
    When you’re starting to hire more employees and want to attract the best talent by offering equity in your company.

What’s the easy way to set up an option scheme?

In the past, setting up and running an EMI Scheme was complicated, time-consuming and expensive. But at SeedLegals, we’ve made it dramatically easier:

  1. create option pool
    This is included with any SeedLegals plan. We’ll automatically generate the documents you need to get the option pool created and agreed by your board and shareholders.
  2. create your valuation report for HMRC
    We guide you through with straightforward questions.
  3. submit your report for review
    Our experts will help you refine your report, to get the best possible valuation discount.
  4. send report to HMRC
    You’ll submit your report directly to HMRC. Then you’ll need to wait to hear from them…
  5. get approval from HMRC
    You’ll get a notification from HMRC to confirm your EMI valuation.
  6. issue share options to your team
    It’s easy via SeedLegals. Your employees will be able to log in to view their options on SeedLegals too, and they can type in any company valuation to find out how much their options might be worth.

If an EMI Option Scheme isn’t right for your team, take a look at creating an Unapproved Option Scheme with us.

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SeedLegals Option Scheme
AJ Alao

AJ Alao

Accounting specialist (and American Football coach) AJ is our expert on option schemes.
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