What if ineligible for EMI?

EMI options remain a flexible and tax-efficient way to provide employees with equity. However, not everyone qualifies for the tax advantages of EMI options. This includes key individuals such as contractors, non-executive directors (NEDs) and founders with substantial shareholdings. We explain alternative equity incentives for those who are ineligible for EMI.

Unapproved options

Unapproved options are generally less tax-efficient than other equity incentives. If options are exit-only, meaning they can only be exercised on the sale of the business, the combined income tax and National Insurance costs can be substantial.

The income tax charge is generally based on the difference between the exercise price and the market value of the shares at exercise. National Insurance contributions may also apply. Employer National Insurance contributions can add to the overall cost, while employee contributions may further reduce the option holder’s proceeds.

Unapproved options are often structured to be exercised on exit because option holders may not otherwise have sufficient funds to meet the tax liability. However, exercising on exit means that the gain is generally taxed as employment income, rather than allowing the increase in value after exercise to be subject to capital gains tax.

Example of tax payable on an unapproved option

The following example illustrates the potential tax costs where a founder director exercises an unapproved option on exit.

Assume the sale proceeds attributable to the option shares are £500,000 and the founder pays nothing to exercise the option.

Share awards

A share award can be structured so that future growth in value is potentially subject to capital gains tax rather than income tax. Capital gains tax rates on shares are generally 18% or 24%, depending on the circumstances. Business Asset Disposal Relief may provide a lower rate where the relevant conditions are met; the applicable rate is 18% from 6 April 2026.

Basic tax charge where shares are awarded

If an employee or employed director receives shares at an undervalue, HMRC may charge income tax and, in some circumstances, National Insurance contributions. The taxable amount will generally reflect the difference between the amount paid for the shares and their relevant tax market value.

Tax market value

Where appropriate, the tax market value may be agreed with HMRC and may be lower than an established investment valuation. Relevant factors include voting control, dividend rights, growth projections and restrictions such as good and bad leaver provisions.

The company’s accounts may also need to be reviewed, including the level of remuneration paid to its directors. If the shares subsequently fall in value, HMRC will not normally refund the income tax paid when they were awarded.

Flowering shares

Flowering shares are initially issued at a low value because their rights are subject to milestones or conditions. Their value increases, or “flowers”, when the relevant targets are achieved.

Restrictions on the shares may reduce their tax market value at the outset. The extent of any reduction depends on the circumstances. If the initial taxable value is low, the increase in value as the shares flower may be subject to capital gains tax.

Designing flowering shares

Flowering shares form a separate class of shares with rights tailored to the intended incentive. Matters to consider include:

• Voting rights;
• Forfeiture provisions;
• Dividend rights; and
• Rights to assets on a distribution.

Different share rights

There is considerable flexibility in designing share rights, but the tax rules are complex. The company’s articles of association and shareholders’ agreement should reflect the intended arrangements. Different tax rules may apply to self-employed contractors and non-executive directors.

Different rights to dividends

Different share classes can carry different dividend rights. For example, investors could receive dividends before founders become entitled to dividends on their shares.

Shares with restricted dividend rights may have a lower tax market value than ordinary shares. Similarly, restrictions on voting rights may affect the value of the shares.

Different slices of sale proceeds

A similar approach can be used for sale proceeds. A separate class of shares could be entitled to receive a second slice of the proceeds after ordinary shareholders or investors have received their agreed priority amount.

Nil paid or partly paid shares

Shares can be issued at full value with some or all of the subscription price left outstanding. This arrangement will not suit every founder, but it may be attractive in the right circumstances.