How are unapproved options taxed?

📘 Overview  

Under an unapproved share option scheme (that is, a scheme which is not one of the tax-favoured ones such as Enterprise Management Incentive (EMI)), employees or contractors are granted options that allow them to buy future shares at a set exercise price.

These schemes often run alongside EMI schemes for those who don’t qualify under EMI rules (for example, overseas contractors or consultants).

Importantly: You pay no tax when the options are granted. Tax arises instead when you exercise the options, that is, buy the shares.

📘 Tax at the Point of Exercise

When you exercise your unapproved share options, the income tax charge is calculated on the difference between:

• the market value of the shares at the exercise date, and
• the exercise price you pay for those shares.

That difference is treated as employment income (or equivalent) and taxed accordingly.

Worked Example

A contractor is granted options over 100 shares at an exercise price of £9 per share.

Three years later, the market price is £20 per share. They exercise the options:

• Cost to exercise = 100 × £9 = £900
• Market value at exercise = 100 × £20 = £2,000
• Taxable income = £2,000 − £900 = £1,100

Income tax will be payable on that £1,100.

🔍 Readily Convertible Shares & Employer PAYE/NIC Obligations

If the shares you acquire are classed as readily convertible assets (RCAs) (for example because there’s the ability to sell them immediately in a liquidity event), then additional rules apply:

• The employer must apply the PAYE system to withhold income tax at exercise.
• Both employee and employer National Insurance contributions (NICs) are due if the shares are RCAs.
• In some cases the employer may ask that the individual covers the employer’s NIC liability instead of the employer.

If the shares are not readily convertible, then:

• Income tax is due via Self Assessment (for the individual).
• No NICs apply at exercise in that case.

📌 Note: The definition of “readily convertible” still depends on whether there are arrangements (or likely arrangements) for the shares to be sold or converted into cash.

📊 Capital Gains Tax (CGT) on Sale of Shares

After exercise, the shares are held as ordinary shares (or comparable assets), so any later gain on sale may be subject to CGT.

Two key scenarios:

Important contemporary points

• The CGT annual exemption (the amount you can gain tax-free) is £3,000 for 2025/26. Vestd+1
• Annual CGT rates for higher/additional rate taxpayers on typical share disposals (not business-asset relief) remain 18 % (basic rate) / 24 % (higher rate) as of current guidance. Vestd+1
• Business Asset Disposal Relief (BADR) (formerly Entrepreneurs’ Relief) may apply if qualifying conditions are met, it now gives 14% from 6 April 2025 (rising to 18% from April 2026). Vestd+1

Example (post-exercise later sale)

Suppose you exercised when market value was £20 per share and you paid £9 per share. Later you sell for £30 per share. You’ll have:

• Income tax on £11 per share (20 − 9) at exercise.
• CGT on £10 per share (30 − 20) at disposal (subject to annual allowance, BADR eligibility, etc).

✅ Summary: Key Practical Points

• No tax is chargeable when the option is granted.
• Income tax is chargeable on exercise of unapproved options: difference between market value at exercise and exercise price.
• If shares are readily convertible assets (RCAs): employer must operate PAYE; employee and employer NICs apply.
• If shares are not RCAs: income tax via Self Assessment; no NICs at exercise.
• CGT may then apply when you sell the shares: after exercise you move to CGT regime for any additional gain.
• CGT annual exemption stands at £3,000 for tax year 2025/26.
• BADR rate is 14% (from 6 April 2025) if you meet the qualifying conditions; expect 18% from April 2026.
• Every case is unique, position may differ for overseas employees, directors, or where options are granted whilst non-resident.