Taxation on EMI Options
Tax advantages of EMI options
There is no income tax or National Insurance contributions charged on the grant of a qualifying EMI option.
If an EMI option is exercised within ten years of the date of grant and there has been no disqualifying event, there will be no income tax or National Insurance contributions due, provided that the employee buys the shares at a price at least equal to the market value they had on the day the option was granted. If the option is a replacement option, it must be exercised within ten years of grant of the original option in order to qualify for tax relief (Section 530 ITEPA).
Taxable exercises of EMI options
Tax can arise on the exercise of a qualifying EMI option if:
- the option was granted as a discount to market value, i.e. the option price is less than the market value at the date of grant (see ETASSUM57030), or
- the option is exercised more than 90 days (40 days prior to 17 July 2013) after a disqualifying event (see ETASSUM57050).
Where the shares acquired are readily convertible assets, tax is accounted for under PAYE and National Insurance is due. If the shares are not readily convertible assets, tax is charged under Self Assessment and no National Insurance is due. Broadly, readily convertible assets are shares that can be sold on a recognised stock exchange or for which trading arrangements are in place, or are likely to be put in place, at the time when the shares are acquired (Section 702 ITEPA 2003).
Charge on the exercise of discounted options
If the option enables an employee to buy the shares at less than their market value at the date the option was granted, there will be an income tax charge when he exercises the option. There will also be National Insurance contributions where the shares are readily convertible assets.
The taxable amount is the lower of:
- the amount of the discount (based on the market value at the date of grant), or
- the difference between the market value of the shares at the date of exercise and the amount paid for them.
Charge on the exercise of an option where the shares are free
Income tax is charged if the employee does not pay anything for the shares when he exercises the option. The charge is on the market value of the shares at the time the option was granted, or if lower, the market value of the shares at the time the option is exercised.
Tax consequences of exercise of an option following a disqualifying event
A number of changes or developments can disqualify an option from EMI relief. These are called disqualifying events. A disqualifying event restricts tax relief.
If the EMI option is exercised within 90 days (40 days prior to 17 July 2013) of the disqualifying event, the tax advantages are preserved.
If the EMI option is not exercised within 90 days (40 days prior to 17 July 2013) (including occasions when the option is not capable of exercise within this time limit) there will be a tax charge on exercise.
The following are disqualifying events:
- loss of independence,
- the company no longer meets the trading activities requirement,
- the employee is no longer eligible,
- changes to the terms of the option,
- alteration to the share capital of the company,
- a conversion of shares, and
- grant of a Schedule 4 CSOP option that takes the option holder over the £250,000 limit.
Charge on exercise of an option following a disqualifying event
If the exercise of an option takes place more than 90 days (40 days prior to 17 July 2013) after a disqualifying event, the exercise is liable to tax. Income tax (and National Insurance, where the shares are readily convertible assets) is charged on the amount by which the market value at the date of exercise exceeds the market value immediately before the disqualifying event.
Charge on exercise of a discounted option following a disqualifying event
If the exercise of an option takes place more than 90 days (40 days prior to 17 July 2013) after a disqualifying event where an option has been granted at a discount, income tax (and National Insurance, where the shares are readily convertible assets) is charged on both the amount of discount and the amount by which the market value of the shares at date of exercise exceeds their market value immediately before the disqualifying event.
Disqualifying events relating to the relevant company
The following are disqualifying events relating to the relevant company, i.e. the company whose shares are under option.
Loss of independence is a disqualifying event except where there is a company reorganisation and a qualifying replacement option is granted. If the relevant company becomes a 51% subsidiary of another company, this is not a disqualifying event if a replacement option is granted that satisfies the EMI legislation (Section 534(2) ITEPA).
If the relevant company no longer meets the trading activities requirement it is a disqualifying event.
A company may have originally met the trading activities requirement because it was preparing to carry on a qualifying trade when the option was granted. There is a disqualifying event if these preparations come to a halt, or if the company (or in the case of a parent company of a group, the relevant group company) does not begin to carry on the qualifying trade within two years of the date of grant of the EMI options (Section 534(4) ITEPA).
Disqualifying events relating to an employee
It is a disqualifying event if an employee who has been granted an EMI option no longer meets employment requirement.
If an employee ceases to be an employee of the company (or in the case of a parent company of a group, any group company) this is a disqualifying event.
A disqualifying event is also treated as having occurred at the end of a tax year if, during this year, the employee’s reckonable employment with the company was less than the statutory threshold of 25 hours per week or 75% of the employee’s working time (Section 535 ITEPA).
Disqualifying events – varying the terms of the option
Any variation to the terms of the option will be treated as a disqualifying event if it:
- increases the market value of the shares that are subject to the option, or
- results in the requirements of Schedule 5 no longer being met (Section 536(1)(a) ITEPA).
Disqualifying events – alterations of share capital
An alteration to the share capital of the company whose shares are under option is a disqualifying event if it:
- affects (or would but for some other event affect) the value of the shares, and
- consists of or includes:
- the creation, variation or removal of a right relating to any shares in the company,
- the imposition of a restriction on any of these shares, or
- the variation or removal of a restriction to which these shares are subject,
and whose effect is that the requirements of Schedule 5 would no longer be met in relation to the options. (Section 536(1)(b) ITEPA)
There will also be a disqualifying event if the alteration to the share capital of the company whose shares are under option
- affects (or would but for some other event affect) the value of the shares, and
- consists of or includes:
- the creation, variation or removal of a right relating to any shares in the company,
- the imposition of a restriction on any of these shares, or
- the variation or removal of a restriction to which these shares are subject,
and
- the change increases the value of the shares, and
- is not made for commercial reasons, or
- is made for the purpose of increasing (or one of the main purposes is to increase) the market value of the shares that are subject to the option (Section 536(1)(c) ITEPA).