David Pett
Partner

What is a share option?

A right to buy existing/subscribe for new shares in future at a price fixed
at time of grant, and normally subject to conditions such as:
◦ continuing employment
◦ attainment of performance targets
◦ sale of the company/business

The gain on exercise of an employee share option (ie mv of shares
acquired, less price paid) is charged to income tax (and, if RCAs, NICs)
– whether or not shares can then be sold

Can transfer burden of employer’s NICs (13.8%) on gain on exercise to
employee , so effective rate of tax/NICs for higher-rate taxpayer in
2012/13 is likely to be 58.9%
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If the shares are “readily convertible assets” (ie are, or will
become, tradeable or the company is not independent):

income tax charges due under PAYE

National Insurance contributions payable
◦ employees’ 2% (above UEL)
◦ employer’s 13.8%
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Employer company can, if independent, claim relief from
Corporation Tax for amount of employee share option gain
(subject to conditions)
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
CGT on sale of shares

But, IT may be charged if:
◦ shares are “restricted” and employee has not paid the full
“unrestricted” value on acquisition
◦ shares are sold for > MV

Entrepreneurs’ Relief (10% rate of CGT) if interest of ≥
5% held for 12 months

Base cost = price paid + IT charged on acquisition
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‘Pro rata’ value
£
Market value for tax purposes
Time
“Leaver”
“Exit”
Any uplift, from a minority interest value to a pro rata value, on exit,
should normally be free of income tax/NICs
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So, what can be done to avoid charges to IT/NICs on
future growth in share value without the need for the
employee to invest in shares for full unrestricted market
value at the outset?
◦ Enterprise Management Incentives
◦ Company Share Option Plans
◦ Share Incentive Plans
◦ Joint Share Ownership Plans
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
Finance Act 2000: First example of legislation produced by an
“independent” government-appointed advisory group

Aimed at small, independent, high-growth companies

No prior HMRC-approval required, but option grants must be
notified to HMRC Small Company Enterprise Centre within 92 days

Share options, but with commercial flexibility as to the exercise price
and when it can be exercised (but must be, if at all, within 10 years
and within 1 year after death)
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
Can set exercise price at below MV (even nil!)

Remember need to pay up nominal value of newlyissued shares

If exercise price < MV, the discount is charged to IT at
time of exercise
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
No IT/NICs, on exercise of the option, on growth in market value
from grant to exercise

If a “disqualifying event” (eg takeover or leaving), relief for accrued
gain not lost, and no loss of relief ,if option is exercised within 40
days

Note: if “restricted” shares acquired on exercise of EMI option with
exercise price = IAMV, then (IUMV – IAMV) falls out of charge

Purpose test: must be for “commercial reasons ….. not ….
avoidance of tax”
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A
“Market value” option: no disqualifying event
B
“Discounted option” : no disqualifying event
MV
MV
£
£
Option gain
exempt from
income tax
Exempt gain
Ex. price
Taxable gain
Ex.price
Time
Grant
Exercise
Time
Grant
Exercise
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C
“Market rate” option: disqualifying event occurs
more than 40 days before exercise
D
“Nil-cost” option: disqualifying event occurs more
than 40 days before exercise
MV
MV
£
£
Taxable gain
Taxable gain
Exempt gain
Exempt gain
Ex. price
Taxable gain
Time
Grant
Disq.
Event
Exercise
Grant
Disq. Exercise
Event
Time
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
CGT payable on sale of shares

Budget 2012: Entrepreneurs’ Relief (ie reduced 10%
rate) available if EMI option shares held by employee for
one year (and all other conditions for ER satisfied except
the need to hold 5%)
◦ not available if EMI option is “exit only”
◦ lobbying for change
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
Company/group must have < 250 fte employees

EMI company/group must have gross assets of < £30m
◦ sum of gross assets of each group company

EMI company must be independent

Must be no arrangements for loss of independence

Must not carry on a disqualifying activity

One group company must have a ‘permanent establishment’
in the UK
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



All subsidiaries under the ‘control’ of the EMI company
must be 51% subsidiaries (and no other person may
have control of it)
Any “property managing subsidiary” must be 90% owned
No arrangements must exist which would cause the
independence or subsidiaries tests to be failed
Beware: pre-emption rights or investment/funding
agreements under which control could be acquired (eg
upon conversion of debt securities if bank covenants not
met etc) in a “meltdown” situation
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
The activities of the company/group must not consist as to a
substantial part (20%) of excluded activities:
◦
◦
◦
◦
◦
◦
◦
◦
◦
◦
◦
◦
dealings in land, commodities, securities (etc)
dealings in goods otherwise than as wholesaler/retailer
banking, insurance, money-lending, debt factoring, financial activities (etc)
leasing or receipt of royalties (subject to exemption for exploitation of selfdeveloped intellectual property)
legal or accounting
property development
farming (etc)
forestry (etc)
shipbuilding or coal and steel producing
operating hotels (etc)
managing nursing homes (etc)
acting as a service company
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
Must be employee of the EMI company or a qualifying subsidiary

Be committed to 25 hours p.w. or 75% of working time

Not have (or be deemed to have) a “material interest”
◦
◦
◦
◦
◦
◦
30 per cent
applied at grant, not exercise
no “look-back” 12 months
interests of “associates” count, but sibling is not an associate
EMI option shares left out of account
other option shares counted but, if subscription options, ordinary share capital is
grossed up
◦ beware existence of EBTs – trust shares disregarded if certain conditions met
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
Overall limit of £3m on aggregate IUMV (at grant) of shares under
all EMI options

Individual limit of (now) £120K on IUMV (at grant) of shares under
EMI (and CSOP) options to any eligible employee
◦ to be increased to £250,000 “ASAP”

Beware re-grants: the ‘3-year rule’: never grant right up to limit of
£[120K]
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
Growth over option period may qualify for CT relief (cf EIS relief)

If shares “restricted”, then any difference between IAMV and IUMV
falls out of charge to tax

If employee leaves then, unless he is allowed to keep it/exercise it, it
merely lapses

Shareholder dilution occurs only at time of exercise

No concern over minority shareholding interests
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



Must be a written option contract granting an
enforceable, albeit conditional, right to acquire shares in
a “qualifying company”
either:
“long-form” bi-lateral contract
or:
rules + “short-form” certificate and agreement to be
bound by rules
Grantor can be company or shareholder or EBT (Note:
employer may get CT relief whoever grants/provides the
shares)
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
HMRC form of notification of grant
◦ includes declaration of eligibility by employee

HMRC annual return on Form 40
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Warning: Remember the 92-day time limit for reporting
grant of an EMI option on Form EMI1
Note also the address to which Form EMI1 should now be sent
(as from April 2012):
Small Company Enterprise Centre
HM Revenue & Customs
First Floor
Fitzroy House
Castle Meadow Road
Nottingham
NG2 1BD
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
“Exit only”
◦ exercisable only upon a sale or change of control (or flotation?)
◦ if employee leaves for any reason, option either lapses or he may retain
whole or part but exercise only if Exit occurs within, say, 5 years

No access to reduced 10% ER rate of CGT on sale

“Vesting schedule”
◦ right to exercise accrues over time

“Performance-linked”
◦ option lapses insofar as performance targets not met
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
If option is capable of being exercised before an Exit, then articles of
association should be checked to ensure proper provision for:
◦ protecting against disposal to a third party
◦ compulsory offer for sale back for value (good leaver) or nominal value (bad
leaver)
◦ permitted transfers to/from an employees’ trust
◦ drag along/tag along

Beware company law problems if articles changed after option
granted
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Usual rules of ss1014 – 1024 CTA 2009 apply:

benefit curtailed if option exercised unnecessarily early

no express statutory CT relief for costs of establishing
EMI option plan – but relief not excluded by s1038 CTA
2009 (and see Final Regulatory Impact Assessment
issued by Inland Revenue in 2000)

ensure set-up costs borne by employer company?
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The treatment of share scheme accounting issues
applicable to SMEs will be covered by William Franklin of
Pett, Franklin & Co. LLP later in this conference
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William Franklin
william.franklin@pettfranklin.com
Office:
Mobile:
Twitter:
0121 348 7878
07889 726 767
www.twitter.com/pettfranklin
David Pett
david.pett@pettfranklin.com
Office:
Mobile:
Twitter:
0121 348 7878
07836 657 658
www.twitter.com/pettfranklin
www.pettfranklin.com
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