Option terms and tax rules
When an employee with share options leaves, or the company is sold, two separate sets of rules apply. The option agreement and the scheme rules decide what the employee is allowed to do: whether the options lapse, how many can still be exercised and by when. Tax law decides how the employee is taxed when they exercise and sell, and whether Enterprise Management Incentive (EMI) options keep their tax advantages.
The two often use different time limits. A scheme may give a good leaver six months to exercise, while the EMI tax advantages only cover the first 90 days after leaving. Founders who draft option terms without looking at the tax rules can end up giving staff a right that costs them more tax than they expected.
The sections below cover leaver terms, what leaving does to EMI options, exercise on a sale and how it is taxed, and the corporation tax deduction the company receives. Our EMI share options page covers setting up a scheme in the first place.
What this guide covers
- Good leaver and bad leaver terms
- EMI options and the 90-day window after leaving
- Exercise on a sale, and cashless exercise
- The employee's tax and the company's deduction
Good leaver and bad leaver terms
Most option agreements sort leavers into two groups, and the company chooses the definitions when it drafts the scheme.
- Good leavers usually include people who leave because of death, ill health, disability, redundancy or retirement, and anyone the board decides to treat as a good leaver. A good leaver typically keeps the options that have vested, meaning the options they have earned by staying for the agreed period, and has a set time to exercise them. Unvested options usually lapse.
- Bad leavers usually include people who resign within a set period or are dismissed for misconduct. A bad leaver's options, vested and unvested, usually lapse on the day they leave.
A common pattern is vesting over four years, with nothing vesting until the end of the first year, called a cliff. An employee who leaves after two and a half years would have vested 62.5% of their options under monthly vesting after the cliff. Board discretion to treat someone as a good leaver is useful, because it lets the company reward a departing employee without changing the scheme.
Some schemes only allow exercise when the company is sold, called exit-only options. A good leaver under such a scheme may keep vested options until a sale, which could be years after they leave. That has tax consequences for EMI options, covered below.
Shares that an employee already owns, because they exercised options or bought shares directly, are governed by the company's articles. These often require a leaver to offer their shares for sale, at market value for a good leaver and at the lower of cost and market value for a bad leaver. Our share structure page covers the articles and the cap table.
What leaving does to EMI options
An employee ceasing to work for the company is a disqualifying event for their EMI options. So is a drop in hours below the working-time requirement of 25 hours a week or 75% of their working time. The rule for each disqualifying event is the same.
- If the option is exercised within 90 days of the disqualifying event, it keeps its EMI tax treatment in full.
- If it is exercised later, the increase in the value of the shares between the disqualifying event and exercise is taxed as employment income. The growth up to the disqualifying event keeps its EMI treatment.
The window was 40 days for disqualifying events before 17 July 2013 and has been 90 days since. The Finance Act 2026 changes to EMI raised the company limits and the exercise period and left the 90-day window unchanged.
If an employee dies, the option agreement can allow their personal representatives to exercise the options, and they must do so within 12 months of the date of death.
Exercise after leaving and Business Asset Disposal Relief
Business Asset Disposal Relief, which taxes gains at 18% for disposals from 6 April 2026, is available on EMI shares where the option was granted at least two years before the sale and the holder was an officer or employee of the company throughout those two years. A leaver who exercises and keeps the shares until a later sale will not meet the second condition, so their gain is taxed at the normal capital gains tax rates of 18% within the basic rate band and 24% above it.
When options lapse
An option that lapses ends with nothing paid and no tax for the employee. The company gets no corporation tax deduction, because no shares were acquired. The shares go back into the option pool, which the board can use for new grants. The lapse should be recorded in the option register and the cap table, and it is reported on the scheme's annual return to HMRC.
Exercise on a sale
When the company is sold, the buyer usually wants to buy every share, including the shares under option. Option agreements usually let options be exercised just before the sale completes, often with all unvested options vesting at that point. The exercise is made conditional on completion, so if the sale falls through the options continue as before.
A buyer taking control of the company is a disqualifying event for EMI options, because the company is no longer independent. Options exercised within 90 days keep their EMI treatment. As an alternative, the buyer may agree to swap the options for equivalent options over its own shares, which keep their EMI status if the replacement meets the conditions and time limits in the legislation.
Cashless exercise
Employees often cannot afford the exercise price, and on a sale they do not need to pay it in advance. In a cashless exercise the employee exercises, the shares are sold to the buyer straight away, and the exercise price and any tax due are deducted from the sale proceeds before the employee is paid. The company, or an agent acting for the sellers, handles the payments under the sale agreement.
For EMI options exercised at or above the market value agreed at grant, only the exercise price is deducted, because there is no income tax at exercise. For unapproved options, or EMI options with a taxable element, the shares can be turned into cash straight away, so the company deducts income tax and employee National Insurance through payroll and pays employer National Insurance at 15%.
The company's corporation tax deduction
When an employee acquires shares by exercising an option, the company can deduct the market value of the shares at acquisition less the amount the employee paid, in the accounting period in which the shares are acquired. The deduction applies to EMI options even though the employee pays no income tax at exercise, and to CSOP and unapproved options.
The shares must be fully paid, non-redeemable ordinary shares, and either listed, in a company not under the control of another company, or in a company controlled by a listed company. A sale to another company means the company comes under that buyer's control, so timing matters. The deduction is still available for options exercised within 90 days of the takeover, provided tax avoidance was not a main purpose of the takeover. If the company has losses, the deduction adds to them.
Worked examples
The figures below are illustrative and use 2026/27 rates for England.
A good leaver who exercises after 90 days
An engineer holds EMI options over 8,000 shares at an exercise price of £1.50, the actual market value agreed with HMRC at grant. They leave after two and a half years, and the board treats them as a good leaver with 5,000 vested options and six months to exercise. The shares are worth £4.00 on the day they leave. They exercise all 5,000 after five months, when the shares are worth £4.60, and keep them.
- The 3,000 unvested options lapse with no tax.
- Exercise is more than 90 days after leaving, so the growth since leaving is employment income: (£4.60 − £4.00) × 5,000 = £3,000. The shares cannot be sold straight away, so this goes on the engineer's tax return with no National Insurance. If the engineer is a higher-rate taxpayer, the income tax at 40% is £1,200.
- If they had exercised within 90 days, none of the gain at exercise would have been taxed as income.
- The company can deduct (£4.60 − £1.50) × 5,000 = £15,500 in its corporation tax computation.
An employee who exercises on a sale
An employee holds EMI options over 20,000 shares at an exercise price of £0.80, granted three years earlier. The company is sold for £9 a share, and the employee exercises just before completion using a cashless exercise.
- Sale proceeds: 20,000 × £9 = £180,000. Exercise price deducted: 20,000 × £0.80 = £16,000. The employee receives £164,000.
- No income tax at exercise. The option was granted more than two years before the sale and the employee worked for the company throughout, so Business Asset Disposal Relief applies.
- Capital gains tax: (£164,000 − £3,000 annual exempt amount) × 18% = £28,980, paid through the employee's tax return.
- The company can deduct £180,000 − £16,000 = £164,000, worth £41,000 at the 25% main rate if it has profits to set it against.
Help with leavers and sales
We check what each leaver's options allow and what tax they would pay on each exercise date, keep the option register and cap table up to date, and on a sale work out the proceeds, the deductions and the company's corporation tax relief for every option holder. Setting up an EMI scheme is £2,950 + VAT, including the valuation agreed with HMRC, and the annual return, which reports lapses and exercises, is £295 + VAT a year.
Related reading
