Long term incentive plans: how awards are taxed

A long term incentive plan (LTIP) is taxed according to what it actually delivers. A cash LTIP is taxed like a bonus when it is paid or the employee becomes entitled to it, while an award of shares is usually taxed when it vests, on the market value of the shares received less anything the employee pays. Where the shares can be readily sold, the employer must operate PAYE and Class 1 National Insurance at that point.

Tax investigation insurance from £108.75 a year (£9.06 a month).Pays up to £100,000 of your accountant's fees if HMRC opens an enquiry. No excess. Buy online in a few minutes.

See my price in 2 questions How the cover works Accountant? Offer cover to your clients or call 01795 841 310

What counts as an LTIP for tax purposes?

HMRC’s Employment Related Securities Manual at ERSM20192 describes an LTIP as a generic name for a plan that aims to provide incentives over the long term, usually a year or more, through a reward linked to shares or securities. It could involve an award of shares, the grant of options or a cash bonus that tracks the share price. The manual is clear that the form the LTIP takes, not its label, decides the tax treatment.

In practice most plans fall into one of four types:

a cash plan, where the payout is measured by profits or by a notional share price (often called a phantom plan);
a conditional share award or restricted stock unit (RSU), where shares are delivered automatically at the end of a vesting period if conditions are met;
a nil cost or market value option that the employee exercises after vesting;
an award of actual shares at the start that can be forfeited if the employee leaves or performance targets are missed.

How is a cash LTIP taxed?

A cash award is earnings under section 62 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). HMRC’s view at ERSM20196 and ERSM110020 is that phantom share plans are simply arrangements for paying cash bonuses measured in a certain way. There is no charge when the award is made, and the cash is taxed in the same way as any other bonus.

The timing comes from section 18 ITEPA: money earnings are treated as received at the earliest of the time payment is made and the time the employee becomes entitled to payment. For directors there are extra triggers when sums are credited in the company’s records or the amount is determined. Because LTIP conditions usually mean there is no entitlement until the vesting date, the tax point is normally the vesting or payment date, not the date of the award. PAYE and Class 1 National Insurance are deducted in that pay period. Our page on phantom share schemes covers cash plans in more depth, and deferred bonuses explains how forfeiture conditions shift the tax point.

Worried about an HMRC check? Tax investigation insurance pays your accountant’s fees if HMRC opens an enquiry or compliance check. Solar Protect cover pays up to £100,000 with no excess. It never pays tax, interest or penalties.

From £108.75 a year (£9.06 a month) for individuals, £117.57 for sole traders and £207.50 for companies and partnerships, including IPT and the £20 admin fee.

See my price in 2 questions or call 01795 841 310.

★★★★★ Rated 4.9 out of 5 on Trustpilot from over 160 reviews

How are share awards taxed on vesting?

ERSM110010 explains that the legal definition of a securities option in section 420(8) ITEPA is simply a right to acquire securities. That is wide enough to cover LTIP awards where the employee does nothing at the end of the vesting period and simply receives the shares. ERSM20192 confirms that from 6 April 2016 an RSU that confers a right to acquire securities is taxed under Chapter 5 of Part 7 ITEPA, the options regime.

Under section 477 the chargeable event is the acquisition of the shares. HMRC’s example at ERSM20194 shows an employee awarded 1,000 RSUs who receives shares worth £4,500 at vesting and is charged to tax on £4,500. If the employee had to pay something, the charge is on the market value less the amount paid. HMRC’s employer guide CWG2 confirms that in most cases there is no charge when an option is granted.

If the employer may settle in cash or shares at its discretion, the employee has no right to acquire securities. ERSM20194 shows that in that case the award is not an option, and the shares or cash received are taxed as earnings when received.

What about shares that are awarded up front but can be forfeited?

Some plans give the employee shares on day one that are forfeited if they leave or targets are missed. These are restricted securities. Section 425 ITEPA provides that no income tax arises on acquisition where the forfeiture provision will lift within 5 years. Instead, section 427 makes it a chargeable event when the shares cease to be restricted (normally the vesting date), when a restriction is varied, or when the shares are sold while still restricted.

The employer and employee can jointly elect under section 425(3) to be taxed on acquisition instead. The election is irrevocable and must be made within 14 days of acquisition. There is also the more commonly used election under section 431 to disregard restrictions; see our guide to section 431 elections before deciding, because paying tax early on shares that are later forfeited is a real risk.

When must the employer operate PAYE and National Insurance?

Section 696 ITEPA treats PAYE income provided as a readily convertible asset (RCA) as a payment of that income, so PAYE applies on the best estimate of the taxable amount. CWG2 lists what counts as an RCA, including shares that can be sold on a recognised investment exchange, shares for which trading arrangements exist or are likely, and securities in a company that is not entitled to corporation tax relief under Part 12 of the Corporation Tax Act 2009. Listed company awards and shares in a private company being sold will usually be RCAs.

CWG2 says payments in the form of RCAs must be included in gross pay for both PAYE and Class 1 National Insurance. Where the shares are not RCAs, PAYE is not operated and the employee reports the income through Self Assessment, although CWG2 notes that cash sums paid in connection with securities attract PAYE and National Insurance even where the securities themselves are not RCAs.

Share awards create a cash flow problem because there may be no cash pay to deduct the tax from. CWG2 explains that any PAYE the employer cannot recover must be made good by the employee within 90 days of the end of the tax year (by 6 July). If not, section 222 ITEPA treats the unpaid tax as further earnings, which is itself taxable. Many plans sell enough shares at vesting to cover the deductions for this reason. Our page on National Insurance on share options covers the contribution side.

What happens to an LTIP when the employee leaves?

Most plans divide leavers into good leavers (for example retirement, redundancy or ill health) and bad leavers (for example resignation to join a competitor or dismissal for cause). The plan rules decide whether an award lapses, vests early, or continues to vest on the normal date, often reduced pro rata. HMRC’s guidance at EIM40013 describes these good and bad leaver categories in bonus plans.

The tax consequences follow what happens:

Award lapses. If nothing is received, there is no income tax charge.
Award vests after the employee has gone. The share rules keep applying after employment ends. Section 421B ITEPA treats securities as employment related where the opportunity arises by reason of a former employment, and those rules only cease 7 years after the employee leaves the group. CWG2 says payments connected with employment related securities made after leaving should be taxed using code 0T on a week 1 or month 1 basis, with the payment after leaving indicator set on the FPS and no new P45.
Compensation for a lost award. A cash sum paid because an option lapses is taxed under section 477(3)(c) as a benefit received in connection with the option, and section 477(6) specifically covers money received for failing or undertaking not to acquire the shares.
Restricted shares bought back on leaving. A disposal for consideration while the shares are still restricted is a chargeable event under section 427(3)(c).

Does the company get a corporation tax deduction?

For share awards, Part 12 of the Corporation Tax Act 2009 provides corporation tax relief for employee share acquisitions, including shares acquired under options and restricted shares; our guide to corporation tax relief for employee shares explains the conditions. For cash LTIPs, section 1288 of that Act applies: if remuneration charged in the accounts is not paid within 9 months of the end of the period of account, the deduction is given in the period in which it is paid. An LTIP accrued over three years therefore usually gets relief when it pays out.

What mistakes come up most often?

Treating the award date as the tax point for a conditional award, or assuming nothing is taxable until the shares are sold.
Failing to run PAYE on RCA awards because no cash changed hands.
Letting the 6 July make good deadline pass, which creates a second tax charge under section 222.
Missing the 14 day window for an election, or making one without thinking about forfeiture.
Issuing a fresh P45 when an award vests after the employee has left, rather than using code 0T and the payment after leaving indicator.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.