How to ensure stock option plans for UK-based employees are tax efficient

In the competitive landscape of global business, attracting and retaining the best talent is often a top priority for international companies. Stock option plans are often offered in remuneration packages to incentivise employees. However, when expanding into the UK market, it's crucial for businesses to understand the intricacies of UK tax law to ensure that their stock option plans remain attractive and tax efficient.

Groups who wish to expand into the UK typically set up an entity here, recruit initial key employees and offer them stock options in the parent entity. Unfortunately, this often isn’t particularly tax efficient for UK employees. 

From a UK employment tax perspective, the granting of a parent country tax-advantaged option, for example a US incentive stock option (ISO) to an employee of a UK subsidiary entity typically does not confer any tax advantages. The stock options will generally be deemed for UK tax purposes to be non-qualifying stock options, and hence any gain from grant to exercise will be subject to income tax and, likely, social security, even if they would be taxed as a capital gain in the parent country.

So, how can businesses ensure tax efficiency when offering stock options for their UK employees? 

It may be possible to structure the issue of stock options in the parent entity to employees of a UK subsidiary via a tax efficient wrapper, such as an Enterprise Management Incentive (EMI) stock option plan or Company Share Option Plan (CSOP). This should allow the UK individual to benefit from UK capital gains tax treatment on the entire gain, for example, from grant of the stock options to the disposal of the shares in relation to the exercised option, similar to the operation of an ISO for US employees. 

What are the advantages of EMI stock options for UK employees?

One advantage of EMI options is that there is no holding period required after exercise in order to secure relief from income tax. The rate of capital gains tax on the disposal of the shares in the UK can be as low as 10%. The issue of stock options under an advantageous plan should also mitigate any social security payable by both the employee and employer, as compared to non-qualifying stock options. 

They are a great tool for incentivising and rewarding UK employees.

Often overlooked steps to establishing an EMI stock option plan

If a UK entity chooses to establish an EMI stock option plan, two key steps with respect to its implementation that are often overlooked, and which result in the loss of tax advantages, are:

1. registering the EMI share scheme with HMRC, the UK tax authority; and
2. once the share scheme has been registered with HMRC, notifying HMRC of all EMI options granted within 92 days of the grant date (from 6 April 2024 this requirement will be replaced with the requirement to register the grant by 6 July following the end of the tax year in which the options were granted).

Currently stock options granted under an EMI arrangement that are not notified to HMRC within 92 days of the grant date, will likely not qualify as EMI tax advantaged stock options. 

If stock options are granted to UK employees and attract employer social security on the gain – calculated as the difference between the market value at the date of exercise and the exercise price – the company will be liable for employer’s social security charge of 13.8% of the gain (at time of writing).

Often, employers seek to mitigate the risks and costs associated with the grant of stock options, by the implementation of a National Insurance contribution (NIC) election. An NIC election in essence transfers the employers’ social security burden legally to the employee. This means that at the time of exercise, there is no social security payable by the employer. 

Any NIC election must also be approved by the UK tax authority in advance, and of course it may be difficult to make employees agree to the election after they have received their options.