Tax Advantages Of Emi Share Options

EMI gives employees very generous tax savings, designed to encourage employee share ownership

The EMI scheme gives employees some very generous tax benefits when they are granted share options. The best way to illustrate this is to first show how an employee would be taxed on a normal PAYE basis, outside of an EMI scheme.

Let’s say that a company is deciding how to award a key employee with an equity stake. A valuation of the shares has been carried out, and they’re worth £5 each today. The company looks at various alternatives including gifting the shares, granting non-EMI options, or granting EMI options.

1. The company gifts 5,000 shares to a manager, which have a tax value of £25,000. This amount is a ‘benefit in kind’ under PAYE rules, so the manager would be liable for income tax on it, costing her £10,000 assuming she is a 40% taxpayer. Having paid that tax, any profit she makes when selling the shares will be taxed at 20% capital gains tax (CGT). She sells the shares in the sixth year when the business is sold in a trade sale, and the acquisition proceeds are £20 per share. She pays CGT of £15,000 (which is calculated as £100,000 proceeds - £25,000 cost of shares x 20%).

    Total tax = £25,000

    2. The manager is granted non-EMI options over 5,000 shares, exercisable after the third anniversary of the date of the grant, at a price of £0.01 per share. She buys the shares in the fourth year, when the market value has increased to £10 per share. Her income tax liability is then based on the £10 value on the date that the options are exercised, so she has to pay income tax of 5,000 shares x £9.99 per share (net of exercise price) x 40% tax = £19,980. Having paid that tax, any profit she makes when selling the shares will be taxed at 20% capital gains tax. She sells the shares in the sixth year when the business is sold in a trade sale, and the acquisition proceeds are £20 per share. She pays CGT of £10,000 (which is calculated as £100,000 proceeds - £50,000 cost of shares x 20%).

      Total tax = £29,980

      3. The manager is granted non-EMI options over 5,000 shares, not exercisable until a sale of the company (an exit event), at a price of £0.01 per share. She exercises the options and sells the shares in the sixth year when the business is sold in a trade sale, and the acquisition proceeds are £20 per share. Her income tax liability will be based on the full £20 value on the date that the options are exercised and sold, so she has to pay income tax of 5,000 shares x £19.99 per share (net of exercise price) x 40% tax = £39,980. Because she has sold the shares immediately to an acquirer, she will also be liable for national insurance, potentially up to some 15.8% currently, so an additional £15,792 cost.

        Total tax = £55,772

        4. The manager is granted EMI share options over 5,000 shares, exercisable on a sale of the company (an exit event), at a price of £0.01 per share. She buys the shares in the sixth year when the business is sold in a trade sale, and the acquisition proceeds are £20 per share. Under EMI, any income tax liability is still based on the value per share on the date that the options were granted six years previously, only £5 per share, so she has to pay income tax of 5,000 shares x £4.99 per share (net of exercise price) x 40% tax = £9,980. Having paid that tax, the profit she makes when selling the shares will be taxed at only 10% CGT. She pays CGT of £7,500 (which is calculated as £100,000 proceeds - £25,000 cost of shares x 10%).

          Total tax = £17,480

          The circumstances in 3 and 4 above are essentially the same, in that the company has granted share options that are exercisable on a company sale. The difference between a non-EMI option and an EMI option is stark: a tax cost saving of £38,282.

          To summarise, the main tax benefits of EMI share option schemes are threefold:

          1. The market value of the options shares is fixed as the value at the date of grant, and this value applies even if the shares are not purchased for up to ten years.
          2. You pay capital gains tax on the profit on sale at only 10% whereas normally you would be charged at a higher percentage of 20% (see note on Budget changes below).
          3. The key point though is that you pay CGT whereas as an employee you would normally have to pay income tax and NIC at full rates if you didn’t have the EMI benefits

          Note on the changes in the October 2024 Budget

          • The rates of Capital Gains Tax (CGT) have increased as follows:
          • The normal rate on the sale of shares has increased from 20% to 24%
          • Business asset disposal (‘entrepreneurs’) relief - available from two years from the date of grant of EMI options, and up to the first £1m of capital gains - the rate increases from 10% to 14% in April 2025 and to 18% in April 2026
          • Although the CGT rates have increased, employees are still far better off using EMI options – without EMI they could pay around 60% PAYE/NI

          Benefit for the company

          Under EMI, the company itself gets a corporation tax offset equal to the total gain made by employees when they exercise their options. It is deducted from profit as a payroll expenses. If employees make a gain of say £1 million, that will directly translate into a tax saving of £190,000 for the company assuming a corporation tax rate of 19%.

          Back to EMI introductory page

          A more comprehensive example of how the EMI scheme works

          Clare has worked for Clever Apps Limited for seven years and she was granted EMI options over 3,000 shares on 1 January 2018. The option exercise price is set at 10p per share, so in total the price of her shares to her will be £300. The price of 10p is the market value per share (for EMI purposes) agreed upfront with HMRC as at the date the options were awarded to Clare.

          The company had structured its option scheme so that option holders could exercise their EMI options (and buy their shares) after a specified period, in Clare’s case on the third anniversary of the grant date. The only thing Clare needed to do initially on the grant date was to sign her option agreement; she does not have to pay out any money until she exercises her options to buy the shares. There is no compulsion to exercise immediately after three years – she has between the third anniversary and either the tenth anniversary or a company sale, whichever is earlier.

          Clare decided to buy her shares just after the third anniversary, so she paid the company £300 and was issued with her share certificate for 3,000 shares.

          In 2023 the major shareholders decide to sell their shares to another company. On the date of completion of the transfer to new owners, all of the share option scheme members including Clare sell their shares to the new owner alongside the major shareholders.

          Let’s assume that the company has been sold at a value that is worth £5 per share. In 2021, Clare had exercised her option to buy her shares, as follows:

          3000 shares granted on 1 January 2014 at 10p each = total cost of £300

          In Clare’s case, her 3,000 shares are sold for £5 each, so her proceeds are £15,000. Her net gain on the sale is therefore £15,000 less the £300 cost of her shares, which equals £14,700. She receives this net amount just after the sale.

          The rate at which capital gains tax is charged on profits made under an EMI share option scheme is only 10%. In Clare’s case, let’s say that she has made no other capital gains in 2023, so her total gain for that year is what she has made under the option scheme. As a result she only pays 10% tax on her gain after deducting her annual CGT allowance. If we assume the allowance is £6,000, she pays tax on £14,700 - £6,000 = £8,700 x 10% = tax of only £870 on a gain of £14,700.

          TECHNICAL SUMMARY - TAX IMPLICATIONS OF EMI OPTIONS

          Note on the changes in the October 2024 Budget

          • The rates of Capital Gains Tax (CGT) have increased as follows:
          • The normal rate on the sale of shares has increased from 20% to 24%
          • Business asset disposal (‘entrepreneurs’) relief - available from two years from the date of grant of EMI options, and up to the first £1m of capital gains - the rate increases from 10% to 14% in April 2025 and to 18% in April 2026
          • Although the CGT rates have increased, employees are still far better off using EMI options – without EMI they could pay around 60% PAYE/NI.

          Grant of Option

          No tax or NICs is payable when you are granted an Option.

          Exercise of EMI Option

          • If the exercise price equals the market value agreed with HMRC at the date of grant, then no income tax is payable.
          • If the exercise price is less than the market value agreed with HMRC at date of grant you will normally have to pay income tax on the difference.

          How the tax is collected

          If any income tax arises when you exercise your Option, how the tax is collected depends on whether the Shares are "readily convertible assets" when you exercise your Option (essentially, this would be on an exit event when there is a ready buyer). If the Shares are readily convertible assets, any income tax will be collected through the PAYE system and you will also have to pay NICs. If the Shares are not readily convertible assets, you will have to pay the income tax through your self-assessment tax return (see below), and you will not have to pay NICs.

          Employer NICs

          If the Shares are readily convertible assets when you exercise your Option, you will be required to pay the employer NICs. However, you can claim relief for this against your income tax.

          Sale of Shares acquired under EMI Option

          When you sell the Shares you acquire under an EMI Option, you will normally be liable to capital gains tax (CGT). The amount charged to CGT is calculated as follows:

          - deduct any amount on which you were liable to income tax when you exercised the Option;

          - deduct the exercise price you paid; and

          - deduct your annual exempt CGT amount (around £12,000). This is a separate allowance from the personal allowance for income tax.

          You will normally be entitled to "entrepreneurs' relief". This means that the first £1 million of gains will be taxed at a 10% CGT rate. Entrepreneurs' relief will not be available in the first 24 months after the Grant Date. Entrepreneurs' relief can be lost or restricted if you transfer your Shares or if you leave the Group's employment before selling your Shares.

          Tax election

          When you exercise your Option, the Company may require you to sign a "section 431 election". If your exercise price is below the market value agreed with HMRC, it may be worth doing a section 431 election. This is a joint election between the company and an employee. The election will mean that you will pay income tax on the discount between the exercise price and the ‘unrestricted market value’ (also agreed with HMRC at grant date), rather than on the difference between exercise price and the restricted market value. It will mean that CGT is payable on any gain over the unrestricted market value, whereas without an election HMRC could levy income tax on the difference between restricted market value and unrestricted market value.