Share option schemes: What you need to know

Alan Boby

Share option schemes have been around for decades and have developed over many years to become sophisticated and to offer many tax breaks*. Questions often arise about the benefits for companies and their employees.

Q. Is it best to set up tax-approved schemes for employees?

A. Generally, the tax rules and reliefs offer reduced income tax and NIC liabilities for tax-approved schemes when compared with non-approved schemes. No national insurance contributions or PAYE need to be paid by the company unless the shares are listed on a stock exchange or otherwise treated as ‘readily convertible assets’ (eg issued in the run-up to a listing or sale). In addition, they can help the Capital Gains Tax (CGT) for employees and the corporation tax position for the company.

Q. How do approved share option schemes work?

A. Taking the example of the enterprise management incentive (EMI) scheme, this allows agreement of the share price before implementation which can give certainty on the income tax outcome and allows the value to be fixed when the scheme starts rather than later when the shares are actually acquired. Any subsequent increase in the share price is normally liable to CGT and entrepreneur’s relief and may also be available to reduce the tax rate to 10%.

Q. Why would a company use a share option scheme?

A. Such schemes can provide a way to incentivise employees for the growth in value of the company and to encourage loyalty to the enterprise (eg share options generally lapse if an employee chooses to leave). The key benefits can be summarised as follows:

  • Providing a genuine long-term incentive both to encourage individual performance to grow company value and to engender company loyalty.
  • Converting part of a director’s/employee’s tax treatment of remuneration from income into capital gain with a lower tax rate and other reliefs.
  • The share value of the option is agreed by HM Revenue & Customs in advance and need not be implemented if seen as too high.
  • Deferring any income tax on the share option until the option is exercised under a tax-approved arrangement.
  • Avoiding national insurance contributions on the share value part of the remuneration package.
  • The company may receive a corporation tax credit when the options are exercised.
  • The ultimate disposal of the shares is usually funded outside the company (ie by the purchaser of the shares).

Q. How would a company use a share option scheme?

A. There are many types of share option schemes but EMI schemes are often seen as the best fit. They are flexible, can be tailored individually for different directors and employees and carry valuable tax breaks. Each scheme will require documents, such as agreement or rules. There are set-up costs such as drafting the scheme rules/agreements and agreeing the share value with HM Revenue & Customs (HMRC). However, these costs are tax-deductible and the company can claim tax relief on the value of the shares when they are issued.

Q. How are schemes reported to HMRC?

A. Apart from the share valuation, all notifications of the scheme events
(eg grant, exercise or lapse of options) need to be reported to HMRC online using their employment related securities (ERS) system. There are strict deadlines for this reporting with penalties for incorrect or late notifications and the risk of losing tax-approved status for the share options. The paper share scheme returns are no longer in use and tax advisers will need to be authorised online by their company clients if they wish to access the ERS system.

*This information is correct as of 1 March 2016 and is subject to changes which may result from the spring 2016 Budget on 16 March.

Alan Boby is member of the UK200Group Tax Panel. Alan can be contacted at Ellacotts LLP on 01295 250 401 or email:

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