Unapproved share options: tax on exercise

Q: How does this work on a sale of the company?

Illustration only. A director holds an unapproved option over 10,000 shares at £1 each. The company is sold, and she exercises immediately before completion, when the buyer is paying £5 a share. Option gain: 10,000 × (£5 − £1) = £40,000, taxable as employment income in the year of exercise. Because the buyer's cash offer is a trading arrangement, the shares are readily convertible, so the company operates PAYE and employee National Insurance on £40,000 and owes employer National Insurance of £6,000 at 15%, unless that liability has been transferred by election. Her Capital Gains Tax base cost is £10,000 paid plus the £40,000 taxed as income (section 119A TCGA 1992), so selling at £5 a share produces no further gain. The company can claim a £40,000 Corporation Tax deduction if the share and control conditions are met at the time of exercise. Her tax must come out of the sale proceeds within 90 days after the end of the tax year to avoid a further charge under section 222.

A share option granted outside SAYE, CSOP or EMI is not taxed when it is granted, but on exercise the employee is charged Income Tax under section 476 ITEPA 2003 on the market value of the shares less the exercise price and anything paid for the option. If the shares are readily convertible assets, the employer must collect that tax through PAYE and pay employee and employer Class 1 National Insurance; if they are not, there is no National Insurance and the employee pays the Income Tax through Self Assessment.

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

When does the tax charge arise?

Under section 475 ITEPA 2003 there is no Income Tax on the grant of an employment related securities option. Instead, Chapter 5 of Part 7 ITEPA 2003 charges a gain when a chargeable event happens (section 477(3)):

shares are acquired under the option, usually by exercise, which also catches rights that vest automatically, such as many long term incentive plans;
the option is assigned or released for money or money’s worth; or
a benefit is received in connection with the option.

The charge falls on the employee even if a family member or other associated person holds the option, and it can still apply to options granted to former or prospective employees. The gain is employment income of the tax year in which the event happens, regardless of whether the shares are sold.

How is the taxable amount worked out?

The taxable amount is the gain less deductible amounts (section 478). On exercise the gain is the market value of the shares at acquisition less the price paid for them (section 479). Deductible amounts under section 480 include anything paid for the option itself and the expenses of the exercise. Market value has its capital gains meaning (section 421, applying section 272 TCGA 1992): the price the shares might reasonably fetch on a sale in the open market. For unlisted shares, section 273 TCGA 1992 assumes the buyer has the information a prudent purchaser would reasonably require.

If the shares acquired on exercise carry restrictions, the restricted securities rules in Chapter 2 also apply, and an election under section 431 can be used to tax the exercise on unrestricted value and remove later charges.

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

When must the employer operate PAYE and National Insurance?

Section 700 ITEPA 2003 treats the employee as receiving PAYE income in the form of the shares, so PAYE applies where the shares are readily convertible assets under section 702. Shares are readily convertible if they can be sold on a recognised investment exchange, or if trading arrangements exist or are likely to come into existence that let the employee obtain cash for them. An exercise on a company sale, where the buyer pays cash for the shares, is the classic case for a private company.

There is a further trap. Under section 702(5A), shares that are not otherwise readily convertible are treated as if they were unless they are shares for which the company is entitled to Corporation Tax relief under Part 12 CTA 2009. Shares in an unlisted company controlled by another unlisted company usually fail that relief test, so exercising options over them is a PAYE event even with no market for the shares.

The employer cannot deduct the tax from the shares themselves, so it pays the PAYE from its own funds and recovers it from the employee. If the employee does not make good the tax within 90 days after the end of the tax year, the unrecovered amount is treated as further earnings under section 222 ITEPA 2003. Where shares are not readily convertible, the employee pays Income Tax through Self Assessment and no National Insurance is due.

Can the employer pass its National Insurance to the employee?

Yes, for option gains. The employer and employee can make a joint National Insurance election transferring the employer’s liability. Since 1 May 2025 an election on HMRC’s pre approved document does not need to be sent to HMRC; it becomes effective once both parties have signed and dated it, and the employer keeps a copy. A self drafted election must be sent for approval, which can take up to 30 days. Alternatively the parties can simply agree that the employee will reimburse the employer’s contributions.

Employer contributions borne by the employee in either way are deductible from the option gain for Income Tax, but not for National Insurance (section 481). For 2026 to 2027 the employer rate on earnings above the secondary threshold is 15%.

What relief does the company get?

The employing company can usually deduct, for Corporation Tax, the market value of the shares at exercise less the amount the employee paid for them and for the option, in the accounting period in which the employee acquires the shares (Part 12 CTA 2009). The shares must be ordinary, fully paid and not redeemable, and if they are unlisted the company must not be under the control of another company, unless that company is listed and not close. The accounting expense for options is a separate question, covered in share based payment under FRS 102.

How does this work on a sale of the company?

Illustration only. A director holds an unapproved option over 10,000 shares at £1 each. The company is sold, and she exercises immediately before completion, when the buyer is paying £5 a share.

Option gain: 10,000 × (£5 − £1) = £40,000, taxable as employment income in the year of exercise.
Because the buyer’s cash offer is a trading arrangement, the shares are readily convertible, so the company operates PAYE and employee National Insurance on £40,000 and owes employer National Insurance of £6,000 at 15%, unless that liability has been transferred by election.
Her Capital Gains Tax base cost is £10,000 paid plus the £40,000 taxed as income (section 119A TCGA 1992), so selling at £5 a share produces no further gain.
The company can claim a £40,000 Corporation Tax deduction if the share and control conditions are met at the time of exercise.

Her tax must come out of the sale proceeds within 90 days after the end of the tax year to avoid a further charge under section 222.

What must be reported to HMRC?

The arrangement must be registered on the ERS online service and an end of year return filed by 6 July following each tax year, reporting grants and exercises of options, or a nil return if nothing happened. A late return triggers an automatic £100 penalty, a further £300 if it is still outstanding three months after the deadline and another £300 at six months. The option gain also goes through the payroll or the employee’s tax return in the normal way.

What mistakes come up most often?

Assuming no PAYE or National Insurance is due because the company is private, without checking trading arrangements and section 702(5A).
Exercising and holding shares without cash to pay the tax, which is due whether or not the shares are sold.
Failing to recover the PAYE from the employee within the 90 day window.
Forgetting a section 431 election where the shares acquired are restricted.
Not registering a one off option grant for ERS reporting.
Using an unapproved option where an EMI or CSOP option was available and would have avoided Income Tax on exercise.

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 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.