How are unapproved options taxed?

  • Under an unapproved option scheme, employees, or contractors, can be granted options that allow them to purchase shares in the future at an exercise price set today.
    • Quite often, we see unapproved option schemes working in parallel with an EMI option scheme, the unapproved scheme might be in place for those individuals that do not qualify for the EMI scheme.
  • Individuals that receive an unapproved option do not pay tax when the options are granted. Instead they pay tax when they exercise their option.
  • The tax is calculated by assessing the difference between the market value at the time of exercise and the amount paid for the shares. This difference is treated as 'income' and is taxed as such on the option holder.
    • For example, a contractor is granted options over 100 shares at an exercise price of £9 per share. The contractor does not pay any tax when the options are granted. In three years time the contractor decides to exercise the options when the market price of the shares are £20 per share.
    • The contractor will pay £900 for the shares, but the market value is £2,000. The contractor pays income tax on the difference of £1,100.
  • Often, individuals will only exercise their option when there is a liquidity event, i.e. there is an option to sell the shares to a third party immediately. This might be, for example, in a VC takeover of the company.
  • If the shares purchased are ‘readily convertible’ (ie during a liquidity event) and the option holder is an employee or director, the company will be obliged to account for the income tax liability through the PAYE system.
    • Both employee and employer NIC will also be due on exercise of the option where the shares acquired are readily convertible.
    • However, on occasion the company can request that the individual bears the employer's NIC liability on behalf of the company.
  • If the shares are not 'readily convertible', then income tax is due on the individual's self assessment tax return, and NIC's are not due.
  • Capital gains tax applies only when the options are converted to shares, i.e. from the date of exercise.
    • If the options are exercised and sold immediately, then the whole increase is subject to income tax.
    • If the options are exercised and subsequently sold at a later date, then part of the increase will be subject to capital gains tax.

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