For UK SaaS startups, equity compensation is the lever that recruits and retains the senior engineers, product leaders and salespeople the company cannot afford to pay at market salaries. The choice of scheme matters: a properly structured Enterprise Management Incentive (EMI) plan is one of the most tax-favoured employee share schemes anywhere in Europe, and an unapproved option scheme by contrast can deliver poor outcomes for both employee and company.
The EMI advantage
EMI options, when granted at market value at the date of grant, deliver:
- No income tax or NIC on grant.
- No income tax or NIC on exercise (provided the exercise price is no less than market value at grant).
- Capital Gains Tax on disposal of shares, with the cost basis being the exercise price paid.
- Eligibility for Business Asset Disposal Relief (where conditions are met, including the relevant minimum holding period and reduction of the EMI working time and shareholding tests), which reduces the CGT rate. BADR rates and limits should be checked at the date of disposal as they have changed in recent Budgets.
By contrast, unapproved options trigger an income tax (and potentially NIC) charge on exercise on the difference between market value at exercise and the exercise price. If the company is listed or the shares are readily convertible, employer NIC at 13.8% can also bite. This is the worst outcome for the employee, who pays income tax on a paper gain they may not be able to monetise immediately, and the worst outcome for the company, which loses the operational benefit of the scheme through the after-tax cost to the employee.
EMI eligibility
Not every UK company can grant EMI. The company-level eligibility tests include:
- Gross assets test: Company must have gross assets of no more than £30m.
- Employee count test: Fewer than 250 full-time equivalent employees in the group.
- Trade test: Must be carrying on a qualifying trade. Most SaaS businesses qualify, but certain excluded trades (such as financial services, property dealing and some others) do not.
- Independence test: Must not be controlled by another company.
- UK presence: Must have a permanent establishment in the UK.
At the option-holder level:
- Working time: The individual must be a full-time employee (committing at least 25 hours a week or, if less, 75% of their working time) of the company or a qualifying subsidiary.
- Material interest: The individual must not already own more than 30% of the company's shares.
- Individual limit: No more than £250,000 of unexercised EMI options (by market value at grant) at any time.
- Company limit: No more than £3m of unexercised EMI options across the company at any time.
Valuation for EMI
EMI options must be granted at market value to secure the no income tax on exercise treatment. Market value can be agreed in advance with HMRC's Shares and Assets Valuation team through a non-statutory clearance. The agreed valuation is typically valid for a defined period after which it can be refreshed. Skipping the HMRC valuation step is one of the most common avoidable errors, because it leaves the option holder exposed if HMRC later challenges the valuation.
Notifying HMRC
EMI grants must be notified to HMRC within 92 days of grant via the online ERS system. Failure to notify within the deadline means the option loses EMI status and falls back to being an unapproved option, with the consequent worse tax treatment. This is another common error, especially with founders moving fast in early-stage rounds.
Disqualifying events
An EMI option can lose its EMI status through a "disqualifying event", including:
- The company ceasing to meet the trading or independence tests (often triggered by acquisition).
- The employee ceasing to meet the working time test.
- A variation in the option terms not permitted by the scheme.
The employee has 90 days after a disqualifying event to exercise the option and retain favourable EMI treatment. Beyond that, any gain on exercise is taxed as employment income.
When unapproved options are appropriate
Despite the tax cost, unapproved options have a place. They can be granted to:
- Non-employee advisers and consultants (who cannot meet the EMI working time test).
- Senior hires above the £250,000 individual EMI limit.
- Companies that have outgrown EMI (over £30m gross assets, 250+ employees) or have lost the trade qualification.
Where unapproved options are used, the tax cost on exercise can be modelled and partly mitigated through holding-company structures or by using growth shares or hurdle shares instead.
Growth shares
Growth shares are a separate route, especially for senior hires above EMI limits. A new class of shares is issued with a hurdle price (typically the company's current valuation), so the new shares only have value above the hurdle. The employee subscribes for these shares at market value (often very low), and future growth is taxed under CGT rather than income tax.
How PushDigits helps
We design and implement equity compensation schemes for UK SaaS startups, including EMI option plans, HMRC valuations, ERS notifications and the parallel statutory accounts disclosures. See our tax planning and business advisory pages, or book a consultation.