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NOTE: This document does not provide legal advice – it is only intended as a
discussion draft to be updated and modified to fit the circumstances. The publishers
and authors shall not be liable to any person with respect to any loss or damages
caused or alleged to be caused directly or indirectly by the information or any mistake
in this document. In particular, all statutory references should be checked and users
are reminded that changes are continually being made to the law and the document
will not be up to date. [24 August 2011]
LEGAL GUIDE
SHARE OPTIONS (NOT EMI)
This note contains a summary of the difference between approved and unapproved share
options. It does not deal with Enterprise Management Incentives options which are
dealt with in a separate briefing note. The note is directed particularly at start-ups and
early stage companies.
1.
Introduction
Share options may either be “approved” by the Inland Revenue, “unapproved”
or Enterprise Management Incentive (“EMI”) options. This note deals with
approved and unapproved options only.
One difference between these options is the tax treatment of the option on
exercise. If approved, there is no tax charge on exercise (and instead it is
delayed until the shares are sold). If unapproved, income tax is payable on
exercise. This tax problem for the option holder is largely overcome if shares
are sold at time of exercise (which is often the case) as income tax at the higher
rate of 40% is same as capital gains tax (“CGT”) at 40% (although the CGT
annual exemption currently £9,600 is not available for the unapproved option).
There are additional problems for the employer with an unapproved scheme as
NIC will be payable on the exercise of the unapproved option and income tax
will require to be collected through the PAYE system if on exercise the shares
are readily realisable.
There is no NIC or income tax payable on the exercise of approved options.
2.
Approved share option schemes
SHARE OPTIONS NOT EMI (GUIDE)
Very broadly, to qualify for relief from income tax on exercise an approved
share option must:-
3.
(a)
be granted under a scheme which is approved by the Inland Revenue;
(b)
be granted only to an employee or a full-time director of the company;
(c)
be exercised at least three years after the date of grant;
(d)
have an exercise price which is not less than the market value of the
shares as at the time of grant;
(e)
ensure no individual is granted an option if the aggregate market value of
his shares exceeds £30,000.
Unapproved schemes
If the option scheme is unapproved:
(a)
there is no statutory limit on the percentage or value of share capital over
which options may be granted to an individual (compare with the
£30,000 limit for the approved scheme);
(b)
there is no minimum period before exercise (compare the 3 year wait for
the approved scheme);
(c)
there is no restriction on exercise price. For approved options, the
exercise price must not be less than the market value and in the case of
unlisted shares, their market value has to be agreed with the Inland
Revenue before an approved share option can be granted;
(d)
provided the option is not exercisable more than seven years after grant,
no liability to tax arises at the time of grant. However, a liability to NI
contributions will arise at the time of grant if the exercise price is at a
discount to market value;
(e)
assuming that the shares will be sold as soon as the option is exercised,
capital gains tax due on the exercise of an approved option (within the
statutory time limits) will be due and payable on 31 January in the
following tax year. For unapproved schemes, income tax would
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normally be due and payable shortly after the end of the tax year in
which the option is exercised;
4.
(f)
if the shares acquired are not immediately sold, the amount on which
income tax is charged on unapproved options is then added to their base
cost for capital gains tax purposes. This means that the amount by
reference to which the indexation allowance is calculated is greater than
it would have been if the shares had been acquired on the exercise of an
approved option within the statutory time limits;
(g)
income tax due on the exercise of an unapproved share option is
collected from the employer under PAYE if the shares are readily
realisable. This imposes an administrative burden and cash flow
disadvantage for both the employer and the option holder.
Procedures
As regards procedure:
(a)
for all schemes Articles of Association and any Shareholders
Agreements will have to be checked to see if the Directors have authority
to grant options;
(b)
the adoption of an unapproved scheme is very straightforward. It is
simply approved by the Board and then you decide which employees
should be invited to participate.
Please be warned though that start-up and early stage companies are often poor
regarding administration of their option schemes. Sometimes they mention at
recruitment that options will be granted. There is then subsequent contradictory
correspondence relating to their employment about options. Even when options
are properly granted sometimes copy letters are not kept and the whole thing
turns into a nightmare. Companies need a good internal administrator to keep a
tight grip on any options granted.
5.
Conclusions
Options granted under the new Enterprise Management Incentives must be the
first choice (if the company is eligible). Please see the separate briefing note
entitled EMI Share Options. If further options are required then the board needs
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to consider the respective merits/disadvantages of approved and unapproved
option schemes. The tax advantages of an approved scheme are compelling but
many start-up and early stage companies are not impressed by the hurdles the
Revenue imposes to have an option scheme approved. There is the £30k limit
but more importantly there is the 3 year wait before the option can be exercised.
For many involved in young, high-growth companies, a wait of 3 years is like an
eternity. An approved scheme is a poor motivational tool compared to an
unapproved scheme where you vest say 20% after say 9 months and 2% a month
thereafter.
For further information please contact:
Tom Mackay or Jennifer Carter Shaw, Solicitors, Mackay Carter Shaw LLP
Tel: 0207 193 1009 or 1016
Email: [email protected] or [email protected]
Website: www.mackaycartershaw.com
This note is only a general review of the subjects covered and does not constitute legal
advice which will vary depending on the circumstances of each case. No legal or
business decision should be based on the contents of this note.
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SHARE OPTIONS NOT EMI (GUIDE)