Tax Rules for Employee Share Options, CSOP, EMI

Offering employees the chance to own a stake in their company is one of the most effective ways to attract, retain, and motivate top talent. Share options—whether offered under a formal tax-advantaged scheme or a more flexible, unapproved arrangement—align employee interests with company growth and can deliver significant rewards. However, the tax treatment of these schemes in the UK is complex, and mistakes can be costly for both employer and employee.

Two Main Categories of Share Schemes

In the UK, share schemes fall into two broad groups:

1. Tax-Advantaged Schemes – Designed to encourage employee ownership with significant tax reliefs, but subject to strict rules.
2. Non-Tax-Advantaged Schemes – More flexible, but often less tax-efficient.

The choice between these depends on your company’s size, growth stage, and long-term goals for employee participation.

Tax-Advantaged Schemes

Tax-advantaged share option schemes are structured to deliver maximum reward with minimal tax exposure, provided the conditions are met. The two most relevant for owner-managed and growth businesses are the Company Share Option Plan (CSOP) and the Enterprise Management Incentive (EMI) scheme.

Company Share Option Plan (CSOP)

CSOPs allow employers to grant selected employees the right to buy ordinary, non-redeemable shares at a set price (the “option price”).

Key features:

• Option Value Limit – Employees can hold up to £60,000 worth of CSOP options at any time.
• Option Price – Must be at least equal to the market value on the grant date.
• Tax Benefits – No Income Tax or National Insurance Contributions (NICs) on the increase in value between grant and exercise, provided conditions are met.
• Exercise Period – Options must be exercised between 3 and 10 years after the grant date. Exercising outside this period removes the tax benefits.
• Eligibility – Companies can choose which employees participate, but part-time directors (under 25 hours a week) and those with a substantial shareholding (30%+) are excluded.

Tax on Sale:  When the employee eventually sells the shares, any gain (sale price minus the option price) is subject to Capital Gains Tax (CGT). If certain conditions are met, the gain may qualify for Business Asset Disposal Relief (BADR), reducing the CGT rate to 10%.

Enterprise Management Incentive (EMI)

EMI schemes are considered the gold standard for small and medium-sized businesses, offering greater flexibility and higher individual limits than CSOPs.

Key features:

• Company Eligibility – Must have fewer than 250 full-time employees and assets under £30 million. Certain “excluded activities” such as banking, insurance, and property development are ineligible.
• Employee Eligibility – Employees must work at least 25 hours a week or devote at least 75% of their working time to the company. They must also hold less than 30% of the company’s shares.
• Option Value Limit – Up to £250,000 per employee; the total value of all EMI options granted by a company cannot exceed £3 million.
• Vesting and Exercise – No minimum holding period, but options must be exercised within 10 years of grant.
• Tax Benefits – If granted at market value, no Income Tax or NICs on exercise. Gains on sale are subject to CGT and typically qualify for BADR without the need to meet the 5% shareholding condition required for other disposals.

Special Rule – Disqualifying Events:  If certain conditions cease to be met (for example, the company’s activities change to an excluded activity), a “disqualifying event” occurs. To keep the tax benefits, employees must exercise their options within 90 days.

Non-Tax-Advantaged Schemes

Non-tax-advantaged (or “unapproved”) share schemes are more flexible in terms of eligibility and structure but lack the tax reliefs offered by CSOP or EMI.

Tax treatment:

• Grant – No tax charge when the option is granted.
• Exercise – If the exercise price is below the market value, Income Tax is payable on the difference. If the shares are considered “readily convertible assets” (i.e., there’s an arrangement in place to sell them for cash), NICs are also due.
• Sale – Any increase in value after exercise is subject to CGT.

These schemes are often used for senior hires who join after a business no longer meets EMI conditions or where more flexibility is needed in structuring the option terms.

Employment-Related Securities (ERS) Reporting

Regardless of the type of share scheme, employers must comply with ERS reporting requirements.

Key points:

• An ERS return must be submitted to HMRC by 6 July following the end of the tax year in which an option was granted, exercised, or shares were otherwise acquired.
• Returns must be filed online, and a return is required even if there were no reportable events during the year (a nil return).
• Late filing penalties start at £100 and increase the longer the return remains outstanding.

Failing to file accurate and timely returns can result in penalties and, in some cases, loss of the scheme’s tax benefits.

Choosing the Right Scheme for Your Business

The right choice depends on a variety of factors, including company size, growth stage, and employee profile.

• Start-ups and SMEs with growth potential – EMI is usually the most attractive due to its generous limits and tax reliefs.
• Larger private companies – CSOP can be a good option, offering flexibility while maintaining favourable tax treatment.
• Companies wanting maximum flexibility – Non-tax-advantaged schemes may suit businesses willing to trade tax efficiency for fewer restrictions.

Practical Tips for Employers

1. Plan Early – Align vesting schedules with performance milestones to maximise motivation and retention.
2. Get a Market Valuation – A defensible valuation is essential for setting the option price and avoiding disputes with HMRC.
3. Keep Detailed Records – Document grant dates, market values, option agreements, and any amendments.
4. Review ERS Deadlines – Mark 6 July on your compliance calendar and ensure you have the necessary Government Gateway access well in advance.
5. Communicate Clearly with Employees – Provide clear, jargon-free explanations of how the scheme works, its tax implications, and what happens if they leave the business.

Why 2025 is a Pivotal Year for Share Schemes

Recent changes in limits and eligibility criteria for CSOPs, as well as ongoing HMRC scrutiny of share valuations, mean employers must be more diligent than ever. With the annual ERS filing deadline approaching each July, now is the time to review your schemes, ensure documentation is complete, and make any necessary updates to comply with the latest rules. Share schemes can be a powerful tool for driving growth and rewarding loyalty—but only if structured correctly and managed in compliance with UK tax rules. Whether you opt for an EMI, CSOP, or a non-tax-advantaged plan, the key is to balance tax efficiency with business needs and to stay on top of your reporting obligations.