What are Unapproved share options?

It might sound like you’re slipping someone share certificates under the table, but there’s nothing underhanded about Unapproved share options. In fact, they’re often the best way to grant equity to your non UK-based employees and anyone else who doesn’t qualify for the EMI scheme.

In this post, we cover exactly what an Unapproved share option scheme is, the tax you need to know about and how to get started with a scheme of your own.

Share option schemes 101

A share option scheme is a structured way to distribute share options to members of your team, like employees, advisors, freelancers and consultants.

Options give the holder the opportunity to buy shares in the future at a pre-agreed price. Later they can sell the shares at the higher value and directly profit from the company’s growth and success.

Our Shares vs options article explains why it’s often better for companies to grant share options, rather than straight shares. In short, the various rules you can attach to the option grant help protect your company and equity over the long term.

See Share options explained for more general detail about the benefits of share options schemes for attracting and retaining your team.

Unapproved options are non-tax-advantaged options

The name ‘Unapproved’ can sound unappealing. And confusing – if you as the founder are taking the time to set up the scheme and define its rules, how can it be unapproved?

Unapproved is a niche term that simply means that it’s not part of the UK government’s ‘approved’ employee share schemes. Approved schemes come with a generous set of tax perks – both for the company granting the shares or share options, and the employee receiving them. The Enterprise Management Incentive scheme (EMI) is the one that’s most relevant to UK startups.

But only certain companies, and specific team members, qualify for the government-backed schemes. If you don’t meet the EMI criteria then your share options can be granted under a non tax-advantaged scheme (ie, Unapproved).

Go Unapproved for non-UK employees or other non-PAYE team members

There are still plenty of advantages to granting share options under a non-tax advantaged scheme. Not least, that setting up an Unapproved scheme is much more flexible and allows you to extend options to more people than you can under the EMI scheme.

Below are the most common reasons you’ll find yourself needing an Unapproved option scheme.

1. You want to give options to team members abroad

The EMI scheme is designed for UK-based employees on your PAYE payroll. If you want to grant options to overseas employees, you’ll need to set up an Unapproved option scheme for them.

Want to grant options to team members in the US or France? Read more of Anthony’s insights in How to give share options to your overseas employees.

2. You want to give options to non-employees (advisors, consultants etc)

The EMI scheme is also unavailable to anyone who doesn’t appear on your PAYE payroll. That includes people you work with on a temporary basis, like independent contractors and advisors.

It’s easy to include these team members with an Unapproved scheme, since you’re in total control of the grant and vesting rules, and the exercise price.

3. Your company is too big or doesn’t qualify

The EMI is designed for small to mid-size independent companies.

If you …

• employ over 250 full-time employees (when you grant the options)
• have over £30M in gross assets
• operate in restricted activities (banking, insurance, investment, property – see the full list)
• are owned by a parent company
• aren’t actively trading in the UK
• aren’t permanently established in the UK

… then your business won’t qualify for the EMI scheme. You can see a complete list of the rules and conditions in the HMRC manual.

4. You’ve already given out EMI options over the allowed value

Under EMI scheme rules, you can only grant options up to the value of £3M. After you’ve reached this limit, you can still grant options under an Unapproved scheme.

Tax on Unapproved share options for team members

With an Unapproved scheme, there’s no special tax treatment for either your team member receiving the options or your company granting them – like there is with the EMI scheme.

Your employees and directors don’t have any tax liability when they are granted their options. Some other team members – like consultants and advisers – will owe tax at that point. Both groups get taxed when they come to exercise their options and sell their shares.

Depending on the terms of the Unapproved option, further tax charges on Unapproved share options for a non-employee can include:

• Income Tax on each vesting milestone and Capital Gains Tax when they exercise their option.
  HMRC will typically charge Income Tax on the (at this stage, hypothetical) difference between the market value of the shares and the strike price (also known as exercise price) paid for them. If an Unapproved share option is taxed on grant, the taxable amount is the difference between the value of the adviser or consultant’s service that is being paid for, minus the costs incurred (which includes the exercise price to be paid).
• Capital Gains Tax is payable when someone sells their shares, on the profit from that sale. If the option holder sells their shares for more than the costs they incurred (including the strike price they paid at exercise), they’ll pay the CGT on the difference.

Remember that if your option holders are resident overseas, they’ll be subject to the tax laws of their own country and should get independent tax advice from a specialist.

Share options can be tricky for your team to understand. We’ve put together some information that explains how they work in Everything your employees need to know about their options. For specific tax advice, your team members should consult an independent tax advisor, who can help them understand the tax liabilities of their option allocation.

Tax on Unapproved share options for companies

When an employee pays Income Tax on their Unapproved share 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. For example, the shares are considered to be ‘readily convertible’ if your company is public, or about to be sold with an arrangement in place to buy the shares.

There’s good news: as the company awarding the options, you can offset the costs of the scheme against your Corporation Tax bill. If you’ve granted Unapproved share options to employees on your company payroll, you can claim a Corporation Tax deduction equal to the Income Tax Charge the option holder pays.

Your company’s exact tax liability depends on how you structure your scheme and your team member’s role within the company. We recommend that you consult a specialist tax advisor as part of setting up your option scheme.

Unapproved share options benefits

The EMI scheme is undeniably the most tax-efficient way for companies to grant options to full-time employees who are tax resident in the UK.

But the flexibility that Unapproved schemes give you has many advantages, such as:

• No limit to the overall value or number of recipients
• More discretion over who you can give options to
• You can decide the strike price and give options below market value (with EMI, you must agree a strike price with HMRC)

How to set up an Unapproved option scheme with SeedLegals

We make it quick and easy to set up your Unapproved share option scheme – and you’ll have expert support to help you design your scheme and decide on the vesting and exercise rules you need.

Here’s how it works:

1. Sign up to SeedLegals – enjoy a 7-day free trial
   You’ll need an annual Share Options Subscription to create your scheme. You’ll get an introductory call from an expert to explain how it all works.
2. Create your 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.
3. Set your scheme rules
   Decide which vesting and exercising rules you want to include in your scheme.
4. Pass the board resolution to adopt the scheme
   It’s quick to get everything signed and stored securely on SeedLegals.
5. Get an expert review of your scheme
   After you’ve set up the grants for your team, we’ll go over everything in your scheme with you to make sure it works for your company.
6. Issue share options to your team
   Send, sign and store all the documents related to the share options on SeedLegals. Your team members can log in as well, to see and manage their allocation.

Talk to the options experts

If you have any questions about the type of scheme that you need, or how to get started, book a slot with an options expert today. We’re happy to help!