Employee share options: how they trigger tax

Whatever the circumstances of your wish to provide perks to staff, there are tax issues to take into account. We look at the common ways that brokers can provide share incentives and the key tax considerations.

Are you a new broker that wants to reward and incentivise staff from the beginning? Or an established broker aiming to incentivise existing employees to drive further growth? Or perhaps you’re looking to bring in a new team and give individuals equity, if certain performance targets are met? Providing share incentives to employees is a great way to encourage them to stay and help develop your business.

But beware. Any transaction in shares that involves a director or employee could create a tax liability for the individual or the employer.

Tax on providing shares or other securities to employees is governed by the employment-related securities rules. These are broad-ranging and can be very complex.

The most straightforward way in which shares can be provided to employees, an award of shares to an employee, will give rise to a tax liability for the individual to the extent that they are not paying market value for the shares when acquired.

In their most simple form, share options can be an easy way to provide incentives to employees. They are given an option to acquire a fixed number of shares at a set value in the future, usually on a specific event (such as an exit) or when certain targets such as income or profitability are met.

Where an employee receives a share option there isn’t a charge to tax on the grant of the option. But a charge can arise on its exercise. The employee will be subject to Income Tax (unless the shares are an RCA, see below) on the difference between the market value of the shares on exercise and any amount they pay on that exercise.

The Enterprise Management Incentives (EMI) scheme is one of the best known tax-advantaged schemes and is widely used by SME brokers. Similar to a standard share option, the scheme works by providing share options to employees, giving them the right to acquire the shares at a set price within 10 years.

EMI differs from standard share options as it allows the business to agree the value of the shares with HMRC on the date the options are granted. If the employee pays an amount at least equal to this agreed valuation on exercise of the options in future, no additional Income Tax is charged to the employee. This means employers can ‘lock in’ the share price on grant, and any increase in value before exercise won’t trigger Income Tax.

But to grant share options under a qualifying EMI scheme, certain conditions must be met. These include some relating to the type of shares they are, whether employees are eligible, and the maximum values that can be granted to an individual and in total. There are also conditions that relate to the business itself, such as its size, independence and what activities it undertakes.

Importantly, while insurance is seen as an excluded activity – therefore preventing these businesses from operating a qualifying EMI scheme – insurance brokers and other insurance intermediaries do not fall within the definition of insurance with HMRC. So brokers can go ahead with an EMI scheme.

The Company Share Option Plan (CSOP) is another tax-advantaged scheme. Unlike EMI, there’s no restriction on the size of the company. So this scheme can be used by larger brokers and other intermediaries or those which might otherwise be excluded from using EMIs.

But the CSOP is more restrictive than EMI as options must be granted at market value, can only be granted over shares worth up to £60,000 per employee and can only be exercised after three years.

Like EMI, on exercise of a qualifying CSOP option, an employee pays the market value of the shares on the date the option was granted. Any increase in value since this date is not subject to Income Tax.

Note that for both the EMI and CSOP schemes, when the shares are sold any increase in value will still be subject to Capital Gains Tax. But these rates are currently significantly lower than the comparative rates of Income Tax.

Common issues

Let’s look at some of the common challenges faced by brokers providing share incentives. In some cases, for example where the benefits of a qualifying tax-advantaged scheme are lost, this can trigger significantly higher tax liabilities for employees and employers.

Has a valuation been undertaken? – In all cases where share incentives are provided to employees, it’s important to calculate the value of the shares. It is this value that’s used to determine whether any amount should be subject to Income Tax. In the case of options granted under an EMI or CSOP, it is the value at grant date that counts for determining whether shares acquired under an EMI option are subject to Income Tax – and it must be included as the exercise price in a CSOP qualifying option.
Has the value of shares under an EMI or CSOP option been agreed with HMRC? – HMRC allows for the value of these shares to be agreed in advance of the options being granted. In the case of EMIs this is done by submitting a completed Form VAL231 to HMRC, along with a supporting valuation calculation, or for CSOPs, contacting HMRC Shares and Assets Valuation directly with the valuation.
Have EMI options been notified to HMRC? – The grant of EMI options must be separately notified to HMRC. Otherwise the tax advantages are lost. Up to 6 April 2024 this notification must have been made within 92 days of the option being granted. From this date the notification must be made before 6 July following the end of the tax year in which the grant is made.
Have annual returns been correctly submitted to HMRC? – Where share incentives are provided to employees, it’s important to complete and submit an annual return to HMRC detailing the activity. The form is different depending on which scheme is used, but in each case it must be submitted by 6 July following the end of the tax year.
Have the qualifying conditions to tax-advantaged schemes been considered properly? – As mentioned, in the case of both EMI and CSOP schemes there are set conditions for a company to grant qualifying tax-advantaged share options. It’s vital for businesses to consider these in detail before awarding the options, to ensure they qualify. If an option granted under an approved scheme turns out not to qualify, from a tax perspective it is treated the same as a standard unapproved option. This can mean significantly higher tax liabilities on exercise.
Are the shares readily convertible assets (RCAs)? – Broadly an RCA is one that, at the time it’s received, is capable of being sold or otherwise realised. This includes listed shares. But it’s more common in the case of SMEs, because the shares are acquired at the point of a sale or exit event. Where shares are RCAs, any amounts that would usually be subject to Income Tax must now be processed through the payroll and subject to PAYE and NICs (both employee’s and employer’s).

If you would like further guidance on share option schemes for brokers, please contact Tom Golding.