What happens when an employee exercises their options?

📘 Overview

When you exercise your share options, you are choosing to buy shares in the company at the exercise price set out in your option agreement. To do this you must notify the company in writing and pay the exercise price. Once the company accepts this, it issues the shares and files a Return of Allotment (form SH01) with Companies House within one month.

📚 EMI Option Exercise Rules

Under the Enterprise Management Incentive (EMI) scheme:

• The option must be capable of being exercised within 10 years of the grant date to retain the tax advantages.
• Even if you exercise later, the ability to buy the shares may remain, but the EMI tax benefits will no longer apply.
• If the exercise price equals (or exceeds) the market value agreed with HM Revenue & Customs at grant, then no income tax is triggered on exercise.
• If the exercise price is less than the agreed value (i.e., granted at a discount), then the difference is subject to income tax on exercise.

🔍 Disqualifying Events

If a disqualifying event affects your EMI option (for example a material change to the business, or you leave employment) you need to consider:

• If you exercise within 90 days of the event, EMI tax advantages can still apply.
• If you exercise after 90 days, the option may lose tax-advantaged status and you may become liable for tax on post-event growth.

💼 Income Tax and National Insurance at Exercise

When you exercise:

• Income tax is due if the exercise price is a discount to the HMRC-agreed value or if post-disqualification growth loses advantage.
• National Insurance Contributions (NICs) may also apply via PAYE if the shares are considered readily convertible assets (RCAs) meaning you could sell them easily for cash (for example by stock exchange or pre-arranged sale).

📊 Disposal of Shares and Capital Gains Tax (CGT)

When you later sell your shares:

• You’ll pay CGT on the gain, which is the difference between the sale proceeds and the amount paid when you exercised.
• If you qualify for Business Asset Disposal Relief (BADR) (the relief formerly known as Entrepreneurs’ Relief), then the CGT rate is reduced.
• From 6 April 2025 to 5 April 2026, the BADR rate is 14 %. From 6 April 2026 onward, the rate is 18 %.
• For EMI-granted shares the conditions for BADR are relaxed in two ways:
  1. The two-year rule counts from the option grant date to the disposal date (rather than exercise date) for qualifying.
  2. The usual “personal company” tests are disapplied.

✅ Key/Practical Points

• Check that your EMI option is capable of exercise within 10 years of grant to retain full tax benefits.
• On exercise: if no discount to HMRC’s agreed market value at grant → no income tax; if discounted → income tax (and possibly NICs) may apply.
• File the company’s SH01 return within one month of share allotment.
• Before disposing: ensure you meet the two-year rule from grant date for BADR, and apply the correct CGT rate (14 % for disposals before 6 April 2026; 18 % after).
• If a disqualifying event occurs, aim to exercise within 90 days to preserve EMI status.