Non-tax-advantaged share option plans

Share plans are important tools for growing businesses, helping them to recruit, retain and incentivise employees. Share option plans fall into two types: those that have statutory tax advantages (tax-advantaged plans) and those that do not receive such tax advantages (non-tax advantaged).

Why choose a share option plan without tax advantages?

Not all companies qualify for tax-advantaged share schemes. Those that do may find the statutory restrictions for tax-advantaged share option plans - the Company Share Option Plan and the Enterprise Management Incentive - unduly restrictive.  

Where tax-efficient structures are not available or not appropriate for your company’s needs, non-tax-advantaged share option plans can form an important element of the remuneration package for your employees. Many businesses need the flexibility they offer - for example, companies can establish non-tax-advantaged share option plans either to stand alone or to ‘top up’ benefits afforded to executives under parallel tax-advantaged arrangements. 

How non-tax-advantaged share option plans work

Under a non-tax-advantaged share option plan, employees chosen at the discretion of the company are granted an option to acquire shares at a specified future date for a price normally set at the date of grant. In tax terms, the company grants a benefit (i.e. the option) to employees and employees only pay income tax when they choose to exercise their options.  

There is no statutory restriction on the level of participation for an employee in a non-tax-advantaged share option plan. However, the company is free to impose restrictions on individual participation and the overall percentage of share capital that can be placed under option to employees (shareholders may insist on such restrictions before they are prepared to accept the adoption of the plan). 

The potential benefit for a director or employee of a fast-growing company can be substantial. Such options can be regarded as a ‘one way bet’ on the company’s share price and many commentators (and shareholders) take the view that such options should only be capable of being exercised if the company’s performance is exceptional. 

Employee tax on non-tax-advantaged share option plans

Income tax is charged on the exercise of the non-tax-advantaged option on the difference between the market value of the shares at the date of exercise and the amount paid to acquire the shares under the option (ie the exercise price). It is important to note that employees wishing to retain their shares rather than sell them immediately following exercise may experience cash flow problems in paying for the shares and/or the tax liabilities arising on exercise. This may encourage sales of shares by employees to enable them to pay the option price and/or their tax liabilities. 

If the shares acquired are ‘readily convertible’ (ie easy to sell for cash) the company will be obliged to account for these income tax liabilities through the PAYE system. For non-tax-advantaged options, NIC will also be due on exercise of the option where the shares acquired are readily convertible (and where the option was granted after 6 April 1999). However, it is possible for the option to be granted subject to the condition that the employee agrees to bear the employer’s NIC liability. 

Capital gains tax will only be applicable from the date the options are exercised. Therefore, if the options are exercised and sold immediately, the full gain arising will have been subject to income tax so no capital gains tax will be due. Alternatively, if the shares are retained after exercise any future growth in value will be subject to capital gains tax on disposal.

Example

An option is granted over 15,000 shares at an exercise price of £2 per share. The option is exercised three years later when the market value of a share is £5. After a further two years (in 2025/26), the shares are sold for £8 per share. Assuming that the shares are readily convertible, the employee’s marginal tax rate is 45 per cent (assuming no change in the highest marginal income tax rate), the full CGT annual exemption of £3,000*  is available to set against any gain on the disposal of the shares (* the CGT annal exemption is currently £6,000 for the 2023/24 tax year but is to reduce to £3,000 in the 2024/25 tax year). Assuming no Business Asset Disposal Relief is available, the employee’s tax position is as follows: 

On grant: No tax is payable.

On exercise	£
Market value on exercise	75,000
Less: Exercise price	(30,000)
Gross gain	45,000
Income tax @ 45%	(20,250)
Employee’s NIC @ 2%	(900)
Net gain	23,850
Employer’s NIC @ 13.8%	6,210

 

On disposal	£
Sale proceeds	120,000
Less: Exercise price	(30,000)
Amount subject to income tax on exercise	(45,000)
	45,000
Less: Annual exemption 2023/24	(3,000)
Chargeable gain	42,000
Capital gains tax @ 20%	8,400

 

Net gain for participant	£
Sale proceeds	120,000
Less: Exercise Price	(30,000)
Income tax	(20,250)
Employee's NIC	(900)
CGT	(8,400)
Net gain after tax	90,450

Employer tax relief on non-tax-advantaged share option plans

Provided that the conditions to obtain statutory relief are met, a corporation tax deduction should be available to the employing company in the period in which the employee exercises the option. The amount on which a deduction can be claimed is the amount on which the employee is subject to income tax. 

UK GAAP and international financial reporting standards require that options granted under non-tax-advantaged share option plans need to be measured at ‘fair value’ and recorded as an expense in the accounts of the employing company.

Expert advice on Share Plans and Incentives

If you have any questions about non-tax advantaged plans, or any other share plans for your business, please get in touch – our team of specialists will be happy to help you.
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