Previously employee share options were mainly offered to senior managers as part of their remuneration package, but it has now become common practice to offer this benefit to employees across seniority levels.
Therefore it is important to the 'squeezed middle' that their taxation is fair. But more needs to be done to tackle two fundamental issues that overshadow their advantages to employees.
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Firstly, a share option is a long-term reward incentive. Its value builds up over several years between when the employee is awarded the option and when they exercise it. And yet all that gain is taxed at one time in one tax year and this is likely to push the tax rate of that ordinary employee from 20% or 40% right up to 47% or even 62%.
This could easily be fixed if the tax rules were changed so the financial gain on a share option was spread over the life of the option and not taxed as a single bullet-point charge on exercise.
The second issue concerns employees with options over shares in unquoted companies. When an employee exercises their unapproved options over shares they have to pay the income tax (and possibly NICs) due when the option is exercised. If their employer is an unquoted company though it will be very difficult if not impossible for the employee to sell their shares and realise their value. Nonetheless, despite there being no way of realising cash from their shares, there’s still an income tax bill for the employee to pay.
This aspect of the tax regime reinforces the UK’s business culture, which doesn’t encourage unquoted companies to exist for the long term. Changing this would be a step towards encouraging fast-growth businesses to stick around and potentially become a large-scale entity like Amazon, Apple and Google.
This issue can simply be alleviated by changing the tax rules so that the income tax due on the exercise of options over shares in unquoted companies is only payable when that company is sold or listed.
Reforms need to be made to mitigate the tax treatment of share options. Where options are granted to middle manager employees, or when they’re granted over shares in a subsidiary company that is excluded from the Enterprise Management Incentives (EMI) plan, the tax on the option gain should be calculated by spreading it over the life of the option.
Even when companies can use the EMI option plan (an initiative that aims to provide advantageous tax treatment for stock options in SMEs), the gain that builds up over the life of the option is still taxable in one go: at or near exercise when the shares are sold.
Implementing these changes will make the rules fairer and clear to employees, and incentivise long-term commitment to the company by enabling workforces to reap the benefits of their share options without having to pay a heavy penalty.
Chris Blundell is an employment tax partner at MHA MacIntyre Hudson
