What happens when an employee exercises their options?
📘 Overview
When an employee exercises their EMI share options, they purchase shares in the company and officially become a shareholder.
This process can have tax implications depending on how and when the options were granted and exercised. This guide explains what happens at each stage, from notification and payment through to tax treatment and potential future capital gains.
🪙 Exercising EMI Options
Step 1: Inform the Company
The employee must notify the company in writing of their decision to exercise the options.
Step 2: Pay the Exercise Price
They must then pay the exercise price set out in their option agreement.
Step 3: Issue the Shares
Once payment is made, the company issues the shares and records the employee as a shareholder at Companies House.
⏱️ Time Limit for Exercising EMI Options
To retain the favourable EMI tax benefits, options must be exercised within 10 years of the original grant date.
Options exercised after 10 years may still be valid from a company law perspective, but the tax advantages will no longer apply.
💰 Income Tax on Exercise
| Scenario | Tax Position |
|---|---|
| Exercise price equals market value (as agreed with HMRC at grant) | ✅ No income tax is due when the employee exercises their options. |
| Exercise price is below market value | ⚠️ Income tax is payable on the difference between the market value at grant and the price paid. |
| Option is disqualified but exercised later | 💡 Any increase in share value between the grant and disqualification date remains exempt from income tax. |
💷 National Insurance Contributions (NICs)
NICs are payable if:
- Exercising the options creates an income tax liability, and
- The shares are “readily convertible assets”, meaning they can be easily sold (e.g. on a stock exchange or where an arrangement exists to buy the shares for cash).
📈 Capital Gains Tax (CGT) on Sale of Shares
When the employee eventually sells their shares, Capital Gains Tax (CGT) may apply.
The taxable gain is calculated as:
Sale price – Exercise price = Capital gain
However, EMI shares often qualify for Business Asset Disposal Relief (formerly Entrepreneurs’ Relief), which reduces the CGT rate to 10%, provided the conditions below are met.
Business Asset Disposal Relief – Conditions
| Condition | Requirement |
|---|---|
| Holding period | Shares must be held for at least 12 months after grant (24 months if granted on or after April 2019). |
| Employee requirement | The individual must be an employee or director at the time of grant and sale. |
| Company requirement | The company must carry on a qualifying trade during this period. |
⚖️ Summary
| Event | Tax Implication | Notes |
|---|---|---|
| Exercising at HMRC-approved market value | No income tax or NICs | Must have valid EMI status |
| Exercising below market value | Income tax due on discount | May trigger NICs if shares are “readily convertible” |
| Exercising after disqualification | Earlier gains remain exempt | Later gains may be taxable |
| Selling shares | CGT applies | May qualify for 10% rate under Business Asset Disposal Relief |