A discussion on the various types of employee share options that can be granted and the tax treatment applicable to each, each with a practical example.

A Simple Guide to Share Option Schemes

Share option schemes are a great way for businesses to incentivize and retain employees by offering them the chance to buy shares in the company at a predetermined price. In the UK, there are both tax-advantaged and non-tax-advantaged schemes available, each with its own benefits and conditions. Let’s break down the most common options available to employers and employees.

1. Tax-Advantaged Share Option Schemes

These schemes offer tax benefits to both employees and employers, making them popular choices for businesses wanting to reward their teams efficiently.

A. Save As You Earn (SAYE)

• What it is: Employees save a fixed amount monthly into a savings account and use the funds to buy company shares at the end of the term.
• Key Features:
• Contract terms of 3, 5, or 7 years.
• A tax-free bonus may be added.
• Maximum savings of £500 per month.
• Discount of up to 20% on the market value of shares.
• Tax Benefits:
• No income tax or National Insurance Contributions (NICs) on grant or exercise.
• Capital Gains Tax (CGT) applies on disposal based on the difference between sale proceeds and the purchase price​.

Example:

Scenario:
Imagine EcoHomes Ltd, a medium-sized construction company, wants to encourage its employees to have a stake in the business while providing them with a risk-free savings plan.

The Goal:
EcoHomes Ltd wants to offer an affordable and tax-efficient way for all employees, including junior staff, to invest in the company’s future and stay motivated.

How a SAYE Scheme Works in This Case:

Granting the Options:

• EcoHomes Ltd offers a SAYE scheme to all employees, including Jack, a project manager.
• Jack decides to save £250 per month over 5 years, which will total £15,000 by the end of the term.
• He is granted the option to buy company shares at a 20% discount, so if the current market price is £5 per share, he can buy them at £4 per share.

Savings Process:

• Each month, £250 is deducted from Jack’s salary and placed into a SAYE savings account, which earns interest tax-free.
• At the end of 5 years, Jack will have £15,000 plus a tax-free bonus, provided he stays with the company.

What Happens at the End of the Term:

• After 5 years, Jack has two choices:
• Exercise the options: If EcoHomes Ltd’s share price has increased to £7 per share, he can buy shares at the pre-agreed discounted price of £4 per share, making an immediate paper profit of £3 per share.
• He can buy 3,750 shares (£15,000 / £4), which at the current market value of £7 are worth £26,250, giving him a gain of £11,250, and only Capital Gains Tax (CGT) will be payable on any gain above the annual CGT exemption.
• Take the cash: If the share price has fallen below £4, he can choose to take the savings plus the bonus instead, risk-free.

Tax Benefits:

• No income tax or NICs when the options are granted or exercised.
• Only CGT applies when the shares are sold, and this can be managed within Jack’s annual exemption.

Why Use a SAYE Scheme?

Risk-Free for Employees:

• If the share price falls, employees can simply take their savings and walk away.

Encourages Long-Term Commitment:

• Employees must complete the savings term to benefit from the share discount, promoting retention.
• Affordable Participation:
• Employees can invest manageable amounts (up to £500 per month) and build a savings habit.

Tax Efficiency:

• The scheme provides tax-free interest on savings and no income tax or NICs on exercising options.

SAYE gives Jack a safe and tax-efficient way to invest in his employer while saving money regularly. If the company performs well, he can benefit significantly from discounted shares. If not, he still walks away with his savings and a tax-free bonus, making it a win-win incentive.

B. Share Incentive Plans (SIP)

• What it is: Shares are held in a trust for employees and can be withdrawn after a specified period.
• Types of Shares Offered:
• Free Shares — Up to £3,600 per year awarded free of charge.
• Partnership Shares — Employees buy shares from pre-tax salary (up to £1,800 or 10% of salary).
• Matching Shares — Employers can offer up to 2 free shares for each one purchased.
• Dividend Shares — Reinvestment of dividends into more shares.
• Tax Benefits:
• No income tax/NIC if shares are held for at least 5 years.
• CGT is only payable on gains after withdrawal from the trust​.

Example:

Scenario:
Imagine GreenTech Ltd, an environmental consultancy firm, wants to encourage employee ownership and long-term commitment by offering shares in the company through a tax-efficient scheme.

The Goal:
GreenTech Ltd wants to reward employees by giving them a stake in the company, motivating them to stay and contribute to its success while benefiting from significant tax advantages.

How a SIP Works in This Case:

1. Granting the Shares:

• GreenTech Ltd sets up a Share Incentive Plan (SIP) and offers employees, including Lisa, an opportunity to participate.
• Lisa is offered different types of shares under the SIP:
• Free Shares: The company awards her £3,000 worth of shares as a reward for performance.
• Partnership Shares: Lisa chooses to buy £1,500 worth of shares using her pre-tax salary.
• Matching Shares: For every share Lisa buys, GreenTech Ltd gives her 2 extra shares for free, meaning she receives £3,000 worth of matching shares.
• Dividend Shares: Any dividends she receives from her SIP shares can be reinvested into buying more shares tax-free.

Conditions and Holding Periods:

• Lisa’s shares are held in a SIP trust for at least 3 years to benefit from tax relief.
• If she keeps the shares in the plan for 5 years, she will not pay income tax or National Insurance (NICs) when withdrawing them.
• If she leaves GreenTech Ltd within 3 years, she may have to pay tax on the value of the shares.

Tax Benefits for Lisa:

• Free and Matching Shares: No income tax or NICs if held for at least 5 years.
• Partnership Shares: Purchased using pre-tax salary, meaning she pays less income tax and NICs.
• Dividend Shares: Any dividends reinvested within the plan are tax-free if held for at least 3 years.
• Capital Gains Tax (CGT): No CGT is due if the shares are left in the trust until sold directly from the plan.

Example Financial Impact:

• Lisa buys £1,500 worth of Partnership Shares.
• The company matches it with £3,000 worth of Matching Shares, and awards her £3,000 in Free Shares, giving her a total of £7,500 worth of shares.
• After 5 years, the share value doubles, and her shares are now worth £15,000.
• Because she kept them in the SIP for the full period, she pays no income tax or NICs, and only CGT if she sells them after withdrawing from the trust.

Why Use a SIP?

Tax Efficiency:

• No tax on shares if held for at least 5 years.
• Tax-free reinvestment of dividends.
• Partnership shares reduce taxable salary, leading to immediate tax savings.

Employee Engagement:

• Encourages long-term investment and loyalty.
• Employees feel more involved in the success of the company.

Flexibility:

• Employees can choose how much to invest via Partnership Shares while benefiting from employer contributions.

Cost-Effective for Employers:

• GreenTech Ltd benefits from Corporation Tax relief and can use SIPs as an alternative to cash bonuses.

With the SIP, Lisa benefits from owning a stake in GreenTech Ltd with significant tax savings and a valuable long-term investment. The company, in turn, builds a loyal and engaged workforce without incurring significant cash expenses upfront.

C. Company Share Option Plan (CSOP)

• What it is: Companies can grant options to selected employees with no discount on the share price.
• Key Features:
• Options up to £60,000 per employee.
• Available to full-time employees with no material interest in the company (>30% shareholding).
• Tax Benefits:
• No income tax/NIC if exercised within 3–10 years.
• CGT applies on disposal of shares​.

Example:

Scenario:
Let’s say GreenTech Ltd, a mid-sized renewable energy company with 100 employees, wants to reward and retain key staff by offering them a stake in the company’s future success.

The Goal:
GreenTech Ltd wants to offer share options to a group of senior employees, providing them with an incentive to stay and contribute to the company’s growth, while taking advantage of tax benefits available under a Company Share Option Plan (CSOP).

How a CSOP Works in This Case:

1. Granting the Options:

• GreenTech Ltd grants options to Emma, a senior engineer, giving her the right to buy 20,000 shares at the current market value of £5 per share.
• The total value of options granted does not exceed the CSOP limit of £60,000 per employee (20,000 shares x £5 = £100,000, but only 12,000 shares worth £60,000 qualify under CSOP rules).
• The options are subject to a 3-year vesting period, meaning Emma can only exercise (buy the shares) after three years if she’s still with the company.

1. Tax Treatment:

• At Grant: No tax implications when the options are granted.
• At Exercise: If Emma exercises the options after 3 years, there is no Income Tax or National Insurance Contributions (NICs) on the difference between the market value and the option price.
• At Sale: If Emma sells the shares later at a higher price (e.g., at £10 per share), she will pay Capital Gains Tax (CGT) only on the gain above the purchase price (CGT on £5 gain per share).

Emma’s Gain:

• After 3 years, the company’s share price rises to £10 per share, and Emma exercises her options at the pre-agreed price of £5 per share, spending £60,000 to buy 12,000 shares.
• She later sells all 12,000 shares for £120,000 (12,000 x £10), making a profit of £60,000.
• Since the gain qualifies for CGT treatment, Emma will pay tax at the capital gains rate (typically 20% for higher-rate taxpayers), rather than the higher income tax rates.

Why Use a CSOP?

Tax Efficiency:

• No income tax or NICs if the options are exercised within the qualifying period (3+ years).
• Only CGT is payable on gains, making it more tax-efficient than unapproved share options.

Employee Retention:

• Employees must wait at least 3 years before they can benefit, encouraging long-term commitment.
• Certainty and Flexibility:
• CSOP allows granting options to selected employees (not all staff), and there’s no need to provide equal terms to everyone.
• The company can set performance conditions tied to the exercise of the options.
• Limits for Risk Management:
• The maximum value of options granted under a CSOP is capped at £60,000 per employee, making it manageable for the company.

With the CSOP, GreenTech Ltd offers Emma an attractive opportunity to participate in the company’s growth while benefiting from significant tax savings compared to salary-based bonuses. The business also gains a tool for retaining talent and aligning employee interests with business success.

D. Enterprise Management Incentives (EMI)

This is by far the most popular share incentive currently

• What it is: A highly flexible scheme designed for smaller businesses to reward key employees with share options.
• Key Features:
• Available to companies with assets under £30 million and fewer than 250 employees.
• Options granted up to £250,000 per employee.
• No income tax or NICs will be due if the options are exercised within 10 years of the grant date, provided they were granted at or above market value at the time of the grant.
• Tax Benefits:
• No income tax/NIC if the option price is equal to market value at grant.
• Significant CGT benefits, including eligibility for Business Asset Disposal Relief (BADR)​.

Example: Let’s say TechWave Ltd, a small software company with 50 employees and a valuation of £10 million, wants to reward its key employees while motivating them to help grow the business.

The Goal:
The company wants to offer share options to its senior developers and managers as an incentive to stay with the company and work towards increasing its value.

How an EMI scheme works in this case:

Granting the Options:

TechWave Ltd grants an EMI option to Sarah, one of its senior developers.
She is given the right to buy 10,000 shares at today’s market value of £1 per share.
These options will “vest” (become available for her to buy) after 3 years, assuming she stays with the company and meets performance targets.
Tax Benefits:

Because the EMI scheme was set up correctly, Sarah doesn’t pay any tax when the options are granted.
When she exercises the options in 3 years (if the share price has risen to £5 per share), she will only pay tax on the gain above the grant price if the options were granted at a discount, but since her options were issued at market value (£1), no income tax is due at exercise.
If she sells the shares later at a higher value, she will only pay Capital Gains Tax (CGT) at a reduced rate, possibly qualifying for Business Asset Disposal Relief (BADR), meaning she pays just 10% tax on the gain.
Sarah’s Gain:

After 5 years, TechWave Ltd is acquired, and the share price increases to £10 per share.
Sarah exercises her options, buying 10,000 shares at £1 each (total cost £10,000), and sells them at £10 each (total sale value £100,000).
Her taxable gain is £90,000 (£100,000 — £10,000), but with EMI, she benefits from BADR and only pays 10% CGT (£9,000 tax instead of higher income tax rates).
Why it’s great for Sarah:
She gets to share in the company’s growth with significant tax savings and an opportunity to profit.

Why it’s great for TechWave Ltd:
They retain a skilled and motivated employee without incurring high immediate cash costs.

In summary, an EMI scheme is a win-win for both employees and businesses — it encourages employees to contribute to growth while offering tax-efficient rewards.2. Non-Tax Advantaged Share Option Schemes

These schemes do not offer tax benefits but provide flexibility for companies to structure employee incentives in a way that suits their needs.

A. Unapproved Share Options

• What it is: A flexible option allowing businesses to grant shares with fewer restrictions.
• Tax Treatment:
• Income tax and NICs apply at the point of exercise.
• CGT applies on disposal​.

Example:
Scenario:
Let’s say StartUp Innovations Ltd, a rapidly growing marketing agency, wants to attract a high-level executive, John, to join their team. They are not eligible for tax-advantaged schemes like EMI due to their large size and the nature of their business.

The Goal:
The company wants to offer John a share option package as part of his remuneration to incentivize him to stay and contribute to the company’s growth.

How an Unapproved Share Option Works in This Case:

Granting the Options:

StartUp Innovations Ltd grants John the option to buy 50,000 shares at £2 per share, which is the current market value.
These options vest gradually over 4 years, meaning he earns the right to buy 12,500 shares each year.
Tax Treatment:

Unlike EMI schemes, when John exercises his option to buy the shares, he will be subject to income tax and National Insurance Contributions (NICs) on the difference between the market value of the shares at that time and the £2 option price.
If the share price rises to £5 when he exercises, he will pay tax on the £3 gain per share (50,000 shares x £3 = £150,000 taxable income).
Capital Gains Tax (CGT) will also apply when he eventually sells the shares, based on any increase in value after the exercise.
John’s Gain:

After 4 years, the company’s share price has grown to £8 per share.
John exercises all his options, buying 50,000 shares at £2 each (total cost £100,000).
At that time, the shares are worth £400,000 (50,000 x £8), meaning he has a taxable income gain of £300,000 (£400,000 — £100,000).
Income tax and NICs will apply on this £300,000 at his marginal tax rate.
If he later sells the shares for £10 each, the additional gain (£500,000 — £400,000 = £100,000) will be subject to CGT at 20%.

Why Use Unapproved Share Options?
Flexibility for the Employer:

No restrictions on the company’s size, type, or structure, making it suitable for businesses that don’t qualify for EMI or CSOP schemes.
Can be offered to part-time employees, consultants, or non-UK-based staff.
Attractive for High Earners:

Allows companies to offer high-value incentives beyond the limits of tax-advantaged schemes (e.g., EMI has a £250,000 cap per employee).
Helps attract senior executives who are motivated by long-term company growth potential.
Short-Term Gains Possible:

Unlike some tax-advantaged schemes, there are no mandatory holding periods, meaning employees can cash out sooner if they wish.

Unapproved share options allow StartUp Innovations Ltd to attract and retain top talent like John without the limitations of government-approved schemes. While tax efficiency is not as favorable, the flexibility and potential for significant financial gain can be highly appealing for senior employees.B. Growth Shares

• What it is: Shares issued to employees that only provide value if the company grows beyond a certain threshold.
• Tax Treatment:
• CGT applies on disposal.
• Suitable for aligning employee incentives with business growth​.

Choosing the Right Scheme

When deciding which share option scheme to implement, businesses should consider:

• Size and stage of the business: EMI is great for SMEs, while CSOPs suit larger, established companies.
• Employee participation: SAYE and SIP schemes are ideal for broader employee engagement.
• Tax efficiency: Tax-advantaged schemes provide significant tax savings.
• Retention goals: Longer vesting periods can help retain key talent.

By understanding the differences between these schemes, businesses can create an effective incentive plan that aligns with their goals while ensuring tax efficiency and compliance.