How are unapproved options taxed?
📘 Overview
Unapproved share option schemes allow a company to grant share options to individuals who don’t qualify for EMI options, typically contractors, consultants, non-executive directors, or overseas employees.
While these options give flexibility, they don’t benefit from EMI tax reliefs, meaning income tax and National Insurance (NIC) can apply when they’re exercised.
This guide explains how unapproved options work, when tax becomes due, and how the timing of exercise or sale affects the tax outcome.
💼 What Are Unapproved Options?
Under an unapproved scheme, the company grants the individual the right to buy shares in the future at an exercise price set on the date of grant.
These schemes often run alongside EMI schemes, covering individuals who don’t meet EMI eligibility requirements (e.g. contractors or overseas workers).
💷 When Is Tax Payable?
Unlike EMI options, no tax is due when unapproved options are granted.
Tax becomes due only when the options are exercised, that is, when the individual actually buys the shares.
The taxable amount is based on the difference between:
the market value of the shares at the date of exercise, minus the exercise price paid.
This difference is treated as employment income and taxed through PAYE (if applicable) or self-assessment.
🧮 Example
| Scenario | Detail |
|---|---|
| Grant | A contractor is granted options over 100 shares with an exercise price of £9 per share. |
| Exercise (3 years later) | The market value of the shares is now £20 per share. |
| Calculation | £20 – £9 = £11 taxable gain per share. £11 × 100 shares = £1,100 taxable income. |
| Result | The contractor pays income tax on £1,100. |
🧾 PAYE, NIC, and “Readily Convertible” Shares
If the shares are considered “readily convertible assets” (RCAs), meaning they can be easily sold, such as during a funding round, exit, or sale, then:
- The company must deduct income tax through PAYE at exercise.
- Both employee and employer NIC are payable.
- The company may (in some cases) agree for the individual to cover the employer’s NIC.
💡 Typical RCA scenarios:
- A liquidity event (e.g. a VC acquisition or secondary share sale).
- Shares that can be sold for cash under an existing arrangement.
If the shares are not readily convertible, then:
- The individual pays income tax via self-assessment, and
- No NICs are due.
📈 Capital Gains Tax (CGT)
CGT applies after the options are exercised, when the individual later sells the shares.
| Timing | Tax Treatment |
|---|---|
| Exercise and sell immediately | The entire gain is subject to income tax (no CGT). |
| Exercise, then sell later | The gain between the exercise value and sale price is subject to CGT. |
💡 The base cost for CGT purposes is the market value at the time of exercise, not the original option price.
🧭 Summary
| Stage | Event | Tax Impact |
|---|---|---|
| Grant | Option awarded | No tax due |
| Exercise | Shares purchased | Income tax due on the difference between market value and exercise price |
| Exercise (with liquidity event) | Shares are “readily convertible” | PAYE + employer and employee NIC due |
| Exercise (no liquidity event) | Shares not readily convertible | Income tax via self-assessment; no NIC |
| Sale | Shares sold later | CGT applies on increase in value since exercise |
🔍 Key Takeaways
💡 1. No tax at grant, only when options are exercised.
💡 2. PAYE applies if shares are readily convertible.
💡 3. NICs may be shared or recharged to the employee.
💡 4. Later sales are subject to CGT, not income tax.
💡 5. Always record valuations and option terms carefully.