Tax implications of selling UK stock options

Chris Broome – Chartered Financial Planner

Share options serve as a valuable tool for start-ups to incentivise, motivate, and reward their employees.

These options can align the team’s interests with long-term company goals and help retain top talent.

To ensure that employees grasp the full potential of their share options, it’s crucial to educate them on the following five key aspects.

Tax implications of selling UK stock options

Understanding Share Options

Share options are contractual agreements provided to employees or other stakeholders, granting them the right to purchase company shares at a predetermined price in the future.

Exercising these options allows individuals to become shareholders in the company. However, the actual value of share options is contingent on the company’s valuation, which may change as the business grows.

Factors like dilution from new investments also impact their value. Employees can estimate their option’s worth by calculating the difference between the strike price (found in the option agreement) and the most recent share valuation, multiplied by the number of options granted.

It’s essential to consider tax implications as well.

Reasons for Awarding Share Options

Start-ups often use share options as a creative way to attract high-calibre talent when they may be financially constrained and unable to offer competitive salaries.

By promising long-term financial rewards, start-ups motivate employees to accept a reduced monthly income while sharing in the company’s potential success.

This strategy motivates the workforce and aligns multiple stakeholders towards the common goal of the start-ups prosperity.

Vesting Schedules

Vesting schedules dictate the timeline over which employees accumulate their share options. Typically, start-ups adopt a four-year vesting schedule with a one-year cliff.

During the first year, no options vest, but 25% of the options vest as a single block after passing the cliff.

Subsequently, options usually vest at monthly intervals, with 50% vesting after two years, 75% after three years, and so on.

A back-weighted vesting schedule, although less common, recognises that employee contributions increase over time and allows for gradual vesting.

Tax Implications

Understanding the tax implications of share options is vital.

In the UK, options are not taxed when granted or fully vested but are subject to taxation upon exercise.

Employees must pay income tax and national insurance contributions (NICs) on the difference between the strike price and share price at exercise.

Capital Gains Tax (CGT) applies when shares are sold during a liquidity event.

Employees usually need to provide the funds to purchase the shares, unless there’s a cashless exercise arrangement with a brokerage.

Employee Option Schemes

Start-ups often establish employee option schemes to make the process of exercising options more tax-efficient for their workforce.

In the UK, several schemes are available, including:

  1. Enterprise Management Incentives (EMI): EMI is the most widely adopted share scheme in the UK. It offers a tax-efficient method to reward, motivate, and retain eligible employees. Notably, options granted under the EMI scheme are exempt from taxation at the exercise stage, including income tax and NICs. Instead, a 10% Capital Gains Tax (CGT) is applicable upon the eventual sale of the shares.
  2. Company Share Option Plan (CSOP): CSOPs represent another government-approved employee option scheme. Employees who exercise their options under this plan do not incur income tax or NICs on the difference between the strike price and the share price. However, you can only exercise these options three years after they were granted, and CGT becomes relevant when you sell the shares.
  3. Share Incentive Plans (SIP): A SIP necessitates that shares be held in a trust for a minimum of five years to enjoy tax advantages. During this period, you are not subject to income tax or NICs on the value of the shares. Additionally, CGT does not apply at the time of sale if you retain the shares within the plan until that point in time.
  4. Joint Share Ownership Plan (JSOP): JSOP is an unapproved scheme that lacks tax advantages. Under this plan, an employee collaborates with a third-party employee benefit trust to jointly acquire shares in the company. Income tax is due when you receive these shares. Subsequently, when you sell the shares, they become subject to CGT.

Each scheme offers distinct tax benefits, making it crucial for employees to understand which scheme applies to them.

Share Option Agreement

A share option agreement is a legally binding contract that grants an individual the right to purchase shares in the future, outlining the conditions and terms for purchase.

These contracts can contain complex terminology, including:

  1. Number of Options Granted: This refers to the total quantity of shares an individual can purchase once they fulfil all the conditions outlined in the agreement.
  2. Strike Price: The strike price is the predetermined rate at which you can buy the shares granted through your option agreement. It is also commonly known as the exercise price.
  3. Vesting Schedule: The vesting schedule is a predefined timetable that dictates when employees can attain complete ownership of the shares allocated to them. Typically, this progression occurs gradually over four years.
  4. Bad Leaver: In the event an employee is dismissed from the company due to serious misconduct, they are classified as a “bad leaver” and forfeit access to any vested options.
  5. Good Leaver: A “good leaver” is an employee who departs the company under favourable circumstances. They have the privilege to purchase any vested options for a specified period after leaving the company. This period typically lasts for 90 days but may vary depending on the company’s policy.

Professional Advice

Share option agreements vary between companies, so seeking legal advice is advisable if there’s any uncertainty about the terms and conditions. Legal specialists can provide professional guidance to ensure employees fully comprehend their agreements.

You will also need to seek out a tax expert to help you understand and calculate any tax liabilities you’re likely to encounter.

Finally, working alongside a trusted financial planner is also advised, ensuring your shares and their disposal align with your short/medium/long term financial planning goals.

Please get in touch if we can be of assistance in either a formal introduction to a trusted legal or tax partner or for a financial planning review.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

Tax advice is not regulated by the Financial Conduct Authority.