Advanced Taxation (UK) · Taxation effects of the financial decisions made by businesses and individuals

Tax Effects of Share Schemes and Employee Rewards

Updated 11 October 2026 · Fact-checked

Share schemes reward staff with shares or options. Tax-advantaged schemes (EMI, CSOP, SAYE, SIP) usually avoid income tax and NIC, leaving a capital gain on sale. Unapproved options are taxed as employment income on exercise. To solve a question, identify the scheme, test its conditions, then compare employee and employer tax and NIC.

Understand Tax Effects of Share Schemes and Employee Rewards

An employee share scheme gives staff a stake in the company. It is a reward, so the default rule is that the benefit is employment income, taxed under income tax and often NIC. Tax-advantaged schemes are the exception. If the conditions are met, the employee pays no income tax or NIC on the benefit. Instead the growth is taxed as a capital gain when the shares are sold.

There are four tax-advantaged schemes you must know. EMI (enterprise management incentive) is for smaller, independent trading companies and is very generous. CSOP (company share option plan) is a discretionary option plan open to any company. SAYE (save as you earn) is an all-employee option scheme funded by monthly savings. SIP (share incentive plan) is an all-employee scheme giving free, partnership, matching and dividend shares held in a trust.

An unapproved option scheme has no conditions, so it is flexible. The cost is tax. There is normally no charge when the option is granted. On exercise, the employee is taxed on the market value of the shares at that date less the price paid. That is employment income. If the shares are readily convertible assets, such as listed shares, NIC also applies, and the employer pays Class 1 secondary NIC at 15% on the gain. The market value at exercise then becomes the base cost for CGT.

The employer side matters too. A company that issues shares to employees can usually claim a corporation tax deduction, subject to the scheme's conditions. Under the unapproved route the deduction is generally based on the employee's taxable gain. A tax-advantaged scheme often saves employer NIC as well, because the employee has no taxable earnings to charge.

The other remuneration choices are cash bonus versus shares, pension contributions by the employer, and benefits in kind. The method is the same each time. Work out the net cost to the employer and the net benefit to the employee under each option. Then recommend the best one and give the conditions that must be met.

Key rules to remember

EMI company and employee conditions: Gross assets ≤ £30m; fewer than 250 employees; independent trading company; employee works at least 25 hours a week or, if less, at least 75% of working time; The unexercised option limit is £250,000 per employee, measured at market value at grant. The company limit is £3m. Options normally must be exercised within 10 years of grant. These are scheme rules to learn, as the tax tables do not list them.
EMI tax treatment: Option price ≥ market value at grant → no income tax or NIC on grant or exercise; CGT on sale = proceeds − exercise price paid; If the option was granted at a discount, the discount is taxed as employment income on exercise. BADR at 14% can apply if the BADR conditions are met, with the two-year period running from grant of the option.
CSOP: Options up to £60,000 per employee at grant; exercise price ≥ market value at grant; exercise 3 to 10 years after grant → no income tax or NIC; Exercise earlier than three years normally gives an income tax charge unless a special reason applies. The gain on sale is taxed under CGT. The limit and periods are scheme rules to learn.
SAYE: Monthly saving £5 to £500 over 3 or 5 years; option price may be up to 20% below market value at grant (price at least 80% of market value); It must be open to all employees. There is no income tax on grant. There is no income tax on exercise using the savings plus bonus, but only if the savings contract runs to completion and the option is exercised in the permitted window. The saving range and contract periods are scheme rules to learn, as the tax tables do not list them.
SIP: Free shares up to £3,600 a year; partnership shares up to £1,800 a year or 10% of salary, whichever is lower; matching up to 2 shares per partnership share; Free, partnership and matching shares need five years in the plan for full relief from income tax and NIC. Dividend shares need a three-year period. Shares taken out earlier create a charge. Open to all employees on the same terms. The limits are scheme rules to learn, as the tax tables do not list them.
Unapproved option: Employment income on exercise = market value at exercise − price paid; No charge on grant. NIC applies if the shares are readily convertible assets. Employer NIC: 15% on earnings above £5,000 a year. Employee Class 1 NIC: 8% to £50,270, 2% above. Base cost for CGT = market value at exercise.
CGT rates and relief: 18% basic rate; 24% higher rate; annual exempt amount £3,000; BADR 14% on up to £1,000,000 lifetime; Use the tax tables given in the exam. Do not rely on memory for rates.

How to solve Tax Effects of Share Schemes and Employee Rewards questions

Use this method for any share scheme or remuneration question. Write the headings in your answer so the marker can follow them.

1Read the requirement. Decide who you are advising (employee, employer or both) and what is being compared.
2Identify the scheme or option. Check each condition against the facts: company size, independence, employee hours, limits, price, and holding period.
3State the tax result at grant, at exercise and on sale. Use the three-stage structure every time.
4Compute the employee's tax: income tax and NIC if there is a charge, otherwise CGT with the annual exempt amount and the correct rate or BADR.
5Compute the employer's position: employer NIC, and the corporation tax deduction where the conditions allow.
6Compare the net cost or net benefit under each alternative with a clear figure.
7Recommend one option and list the conditions that must be kept, such as holding periods or limits.
8Add a brief comment on risks, such as losing the relief by breaching a condition.

Quickest way: Three-stage grid

When to use it: Use it when time is short or when several schemes or reward options are compared.

Draw three columns: grant, exercise, sale.
For each option, write the tax charge in each column. Tax-advantaged schemes: nil, nil, CGT. Unapproved: nil, employment income and possibly NIC, CGT on later growth.
Compute the big charge first. For unapproved options this is the exercise gain times the tax rate, plus NIC. For tax-advantaged schemes it is the gain after the annual exempt amount at 14%, 18% or 24%.
Add the employer NIC and the corporation tax effect.
Take the difference in net cost and write the recommendation with conditions.

Common mistakes in Tax Effects of Share Schemes and Employee Rewards

Charging income tax on exercise of a qualifying EMI option granted at market value.
Students apply the unapproved rule to every option.
Fix: Check the EMI conditions first. If met and the option price was at least market value at grant, there is no income tax or NIC on exercise. Tax the gain under CGT.
Using the market value at grant as the CGT base cost for an unapproved option.
Confusion over which date matters.
Fix: For unapproved options the base cost is the market value at exercise, because that value was taxed as income. For EMI the base cost is the price paid.
Forgetting employer NIC on the gain from unapproved options over readily convertible assets.
Students focus on the employee's tax only.
Fix: Always add employer NIC at 15% when there is a taxable earnings charge, and say whether the shares are readily convertible.
Ignoring scheme limits and holding periods.
Students treat the schemes as automatically tax-free.
Fix: Test the limits: EMI £250,000 per employee, CSOP £60,000, SIP £3,600 free shares. Test the periods too: CSOP three years, SIP five years for free, partnership and matching shares, and three years for dividend shares. These are scheme rules, not in the tax tables, so learn them. Say what happens if they are breached.
Applying BADR to the sale without checking the conditions.
Students remember that EMI shares can qualify.
Fix: Say BADR is available only if its conditions are met, including the holding period measured from grant for EMI, and apply the 14% rate to the qualifying gain.
Forgetting the annual exempt amount of £3,000 when computing CGT on a share sale.
Students go straight to the rate.
Fix: Deduct the annual exempt amount unless the facts show it is already used.

Worked examples

Example 1

Amit, an employee of a small trading company, is a higher rate taxpayer with no other gains. His earnings already exceed £50,270. He was granted an option over 10,000 shares at £5 a share, the market value at grant. He exercises when the value is £12 and sells at once. Compare the tax if the option is (a) a qualifying EMI option and the BADR conditions, including the two-year period from grant, are met, and (b) an unapproved option over readily convertible shares. Use income tax at 40%, employee NIC at 2% and employer NIC at 15%.

Show the solution

(a) EMI: no income tax or NIC on grant or exercise, as the price paid equals market value at grant.
Gain on sale = (£12 − £5) × 10,000 = £70,000.
Less annual exempt amount £3,000 = £67,000 taxable.
BADR at 14%: £67,000 × 14% = £9,380.
Employee NIC and employer NIC: nil.
(b) Unapproved: employment income on exercise = (£12 − £5) × 10,000 = £70,000.
Income tax at 40% = £28,000.
Employee NIC at 2% × £70,000 = £1,400.
Sale at £12 gives no gain, because the base cost is the £12 market value at exercise. No CGT arises.
Employer NIC at 15% on £70,000 = £10,500.
Total cost to Amit and employer under (b) = £28,000 + £1,400 + £10,500 = £39,900, against £9,380 under (a).

Answer: Under EMI, Amit pays £9,380 of CGT and there is no NIC. Under the unapproved route Amit pays £28,000 of income tax and £1,400 of employee NIC, and the employer pays £10,500 of NIC. The total is £39,900. The EMI scheme is clearly better, provided its conditions are kept.

Example 2

A company wants to give Bina, a higher rate taxpayer, £3,000 of reward. It can pay a cash bonus or give £3,000 of free shares under a SIP that Bina will hold for at least five years. Compare the tax effect for Bina and the employer. Use 40% income tax, 2% employee NIC and 15% employer NIC. Ignore share price changes.

Show the solution

Cash bonus: income tax at 40% × £3,000 = £1,200.
Employee NIC at 2% × £3,000 = £60.
Bina's net receipt = £3,000 − £1,200 − £60 = £1,740.
Employer NIC at 15% × £3,000 = £450.
SIP free shares held five years: no income tax and no NIC.
Bina's benefit = £3,000 of shares. Employer NIC = nil.
Difference for Bina = £3,000 − £1,740 = £1,260 better off.
Difference for the employer = £450 NIC saved. Corporation tax deduction is available in both cases, subject to conditions.

Answer: The SIP free shares leave Bina £1,260 better off and save the employer £450 of NIC, provided the shares stay in the plan for five years and the £3,600 annual limit is respected. Bina will pay CGT on any later growth when she sells.

Exam tips

Start every share scheme answer with the scheme and whether its conditions are met. Marks go to testing the conditions, not only to the calculation.
Use the grant, exercise and sale structure. It is the easiest way to show what is taxed and when.
Show the employer's position as well as the employee's: NIC and the corporation tax deduction are regularly forgotten.
Take rates and limits from the tax tables in the exam. Give the NIC, CGT and BADR figures from there. Learn the scheme limits, as the tables do not list them.
In advice questions, finish with a clear recommendation, a figure for the saving and the conditions to be kept. These earn professional skills marks.

Practice questions from Taxation effects of the financial decisions made by businesses and individuals

Tax Effects of Share Schemes and Employee Rewards: frequently asked questions

What is the difference between EMI and CSOP?

EMI is for smaller independent trading companies, with a £250,000 per employee limit and a £3m company limit. CSOP is open to companies of any size, with a £60,000 per employee limit at grant. Both can avoid income tax and NIC on exercise if the conditions are met.

How are unapproved share options taxed?

There is normally no charge on grant. On exercise, the gain (market value at exercise less price paid) is employment income. NIC applies if the shares are readily convertible assets. The market value at exercise is the CGT base cost.

Do SAYE and SIP have to be offered to all employees?

Yes. Both are all-employee schemes and must be offered to all qualifying employees on similar terms. EMI and CSOP are discretionary, so the company chooses who receives options.

Can BADR apply to shares acquired under EMI?

It can, if the BADR conditions are met. For EMI shares, the qualifying period is measured from the grant of the option. The gain is taxed at 14% within the £1,000,000 lifetime limit.