Unapproved Share Options And Growth Shares: Where Income Tax Ends And CGT Begins
Index:
Unapproved Share Options and Growth Shares: Where Income Tax Ends and CGT Begins
Unapproved share options are taxed to income tax and National Insurance on exercise, on the difference between the market value of the shares and what the employee pays for them, under Chapter 5 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). Growth shares are taxed differently: if structured and valued correctly at acquisition, there is little or no income tax charge at that point, and the entire subsequent increase in value is taxed as a capital gain on sale. Getting this boundary wrong, in either direction, is one of the most expensive mistakes I see in private company equity planning.
Founders and finance directors tend to reach for "unapproved options" or "growth shares" almost interchangeably when Enterprise Management Incentive (EMI) options are not available or not appropriate, and the two are genuinely different mechanisms with genuinely different tax outcomes. I want to set out precisely where the line sits, because the difference between employment income at up to 45% (48% for a Scottish taxpayer) and a capital gain at 18% or 24% on the same pound of value is not a rounding error.
Where Income Tax Applies: Unapproved Options on Exercise
An unapproved, or non-tax-advantaged, share option is simply an option granted outside EMI, Company Share Option Plan (CSOP), or Save As You Earn (SAYE) rules. There is generally no income tax charge when the option is granted. The charge arises on exercise, under section 476 ITEPA 2003, and is calculated as the market value of the shares at the moment of exercise, less anything the employee paid for the option itself, less the exercise price paid for the shares. That figure counts as employment income for the tax year in which exercise happens, in full, regardless of how long the option was held before being exercised.
This is the point that catches people out most often: holding an unapproved option for five years before exercising it does nothing to convert any of that value into a capital gain. The entire spread at exercise is income, taxed at up to 45% (up to 48% for a Scottish taxpayer, since this is non-savings, non-dividend income taxed under Scottish rates and bands), regardless of how long the underlying right existed beforehand. Only growth in value after exercise, once the employee actually holds shares rather than an option, is capable of being a capital gain.
Unapproved Share Options vs Growth Shares: Interactive UK Tax & Boundary Calculator
Navigating the tax frontier between unapproved share options and growth shares is critical for UK founders and employees, as the distinction between employment income tax and Capital Gains Tax (CGT) can mean a swing of up to thirty percentage points on real returns. This interactive dashboard allows you to explore precisely where income tax ends and CGT begins, model your net exit proceeds, and examine key variables such as Scottish tax divergence, Readily Convertible Asset (RCA) status, and employer National Insurance offsets. To get started, simply toggle between equity structures in the lifecycle tabs, input your valuation figures into the dual-model calculator, and adjust your personal tax settings to view an instant visual breakdown of tax liabilities and net outcomes.
The PAYE and NIC Complication: Readily Convertible Assets
Whether the exercise gain has to go through payroll, rather than simply being reported and paid via Self Assessment, depends on whether the shares are a "readily convertible asset" (RCA) at the time of exercise, broadly meaning there is a market or arrangement that would let the employee turn the shares into cash reasonably quickly. Private company shares are frequently not RCAs at the point of exercise, in which case there is no PAYE or employee National Insurance contributions (NICs) obligation at that moment, though the gain still has to be reported through the Self Assessment return and Class 1 NIC can become due later on an actual disposal if the RCA condition is met by then.
Where the shares are RCAs, typically because the company has a trading market, is about to be sold, or has arrangements in place that make a quick sale realistic, the employer must operate PAYE and Class 1 NIC on exercise. For 2026/27, employee Class 1 NIC is charged at 8% on earnings between the Primary Threshold of £12,570 and the Upper Earnings Limit of £50,270, and 2% above that, while employer Class 1 NIC is charged at 15% on earnings above the £5,000 secondary threshold, with no upper limit.
On a large exercise gain around an exit, the employer's NIC exposure at 15% on the full uncapped spread can be a substantial and easily underestimated cost, and it is worth agreeing in the option documentation, well before exercise, whether the employer intends to recover any of that secondary NIC liability from the employee, since this is permitted under sections 481 and 482 ITEPA 2003 but has to be arranged properly to be effective.
Why Companies Use Unapproved Options at All
Given the tax profile above, it is fair to ask why any company would choose unapproved options over EMI. The honest answer is usually eligibility, not preference. EMI is restricted to independent trading companies, and until recently a company had to have gross assets under £30 million, fewer than 250 full-time equivalent employees, and no more than £3 million of unexercised EMI options outstanding at any time.
From 6 April 2026, those limits expanded materially. HMRC's policy paper on expanding the eligibility limits of the Enterprise Management Incentive scheme confirms the gross assets limit rises to £120 million, the employee limit rises to 500, and the company-wide EMI option pool doubles to £6 million, with the qualifying exercise period extended from 10 to 15 years. The £250,000 individual employee limit is unchanged. This is a genuinely useful moment to revisit unapproved arrangements put in place in the last two or three years specifically because the company had outgrown the old EMI thresholds. A scale-up that fell out of EMI eligibility at £35 million of gross assets under the old rules may now be comfortably back within scope, and existing unapproved option holders could potentially be moved onto, or granted fresh, EMI options going forward, though this needs care and does not retrospectively change the tax treatment of options already exercised.
Beyond size, EMI also excludes certain trades (financial services, property development, and a handful of others), excludes non-employees such as non-executive directors and consultants, and caps any individual's options at £250,000 of unrestricted market value. Companies with excluded activities, or wanting to incentivise a consultant or a non-executive who falls outside EMI's employee-only rules, generally have no route to a tax-advantaged option at all, and unapproved options are the fallback.
Growth Shares: A Different Mechanism, the Same Underlying Question
Growth shares work on an entirely different principle. Rather than granting a right to acquire shares in future, the company issues actual shares now, but as a distinct class that only participates in value above a set hurdle, typically set at or close to the company's current valuation. Because the shares have no economic value below the hurdle, their genuine market value at the point of issue can be very low, sometimes a few pence per share, even though the company itself may already be worth millions.
If the employee pays that low market value in full at acquisition, there is little or no income tax charge at that point, because there is no shortfall between what was paid and what the shares were actually worth.
From that point on, the shares are simply capital assets. Any increase in the shares' value above what the employee paid is a capital gain on eventual sale, potentially eligible for Business Asset Disposal Relief (BADR) if the usual conditions are met, including a minimum two-year holding period, at least 5% of the ordinary share capital and voting rights, and the company being a personal trading company in relation to the employee throughout that period. For 2026/27, BADR applies an 18% rate to qualifying gains up to a £1 million lifetime limit, a rate confirmed in the gov.uk guide to Business Asset Disposal Relief, with the standard CGT rates of 18% and 24% applying above that limit or where BADR is not available.
Everything about growth shares turns on getting the acquisition-time valuation right and correctly documented, because if HMRC later takes the view the shares were worth more than the employee paid, the shortfall becomes an income tax charge under the employment-related securities rules, potentially applied retrospectively once it matters most, at the point of an exit, when scrutiny is highest.
Unapproved Share Options vs Growth Shares Tax Boundary
Incentive Mechanism | Income Tax Boundary (Where Income Tax Applies) | CGT Boundary (Where Capital Gains Tax Begins) |
Unapproved Share Options | Applies at exercise on the spread/gain (difference between the market value of the shares at exercise and the exercise price paid/cost) 1-18. No tax at grant 1, 2, 5, 10, 13, 18 unless granted at a discount or transferable 1, 5. With a Section 431 election, tax applies strictly at exercise on the unrestricted market value spread 12; without a Section 431 election, income tax continues to apply to post-exercise growth as restrictions lift 12. Also applies if cancelled or assigned for cash/assets 6. | Applies on any subsequent growth in share value post-exercise between the market value established at exercise (plus consideration/tax paid) and the eventual sale/disposal price 1-6, 8-10, 12-18. |
Growth Shares | Applies at acquisition/issuance on any initial discount/shortfall if shares are acquired for less than their market value / unrestricted market value 1-3, 6-8, 10-12, 16, 17, 19-22. No income tax on exercise/disposal 2, 9, 20. With a Section 431 election, tax is locked in upfront on the UMV discount with no further income tax on growth 6, 17, 19, 22; without a Section 431 election, a proportion of future growth/exit value can be taxed as income tax 6, 19. | Applies upon sale/disposal on all future capital growth in share value achieved above the initial acquisition cost/hurdle threshold price 1-3, 6-12, 16, 17, 19-23. |
The Section 431 Election: The Document Most Founders Sign Too Late, or Not At All
Growth shares, and many unapproved share awards generally, almost always come with some form of restriction: forfeiture if the employee leaves within a set period, transfer restrictions, or good leaver and bad leaver provisions. Under the restricted securities rules in Chapter 2 of Part 7 ITEPA 2003, restricted shares are, in the absence of an election, valued for tax purposes at their restricted value at acquisition, but future increases in value attributable to the lifting of those restrictions can themselves become subject to income tax later, precisely the outcome growth shares are usually designed to avoid.
A joint election under section 431 ITEPA 2003, signed by the employee and the employer, fixes the tax position at acquisition using the shares' unrestricted market value rather than their restricted value, and in return removes any further income tax exposure on the restrictions being lifted or the shares later converting to an unrestricted class. The election must be signed within 14 days of acquisition, with no extensions and no exceptions under HMRC practice, and it does not need to be filed with HMRC at the time, though both parties should retain a signed copy since HMRC can ask for it on enquiry.
I have seen this go wrong more than once in the same way: growth shares issued with a genuinely low hurdle-adjusted value, the company entirely correct that little or no tax is due at acquisition, but no section 431 election signed within the 14-day window, because nobody flagged that it mattered given there was "no tax to pay anyway." Years later, at an exit, HMRC can and does examine whether the restrictions were lifted and, without a valid election in place, seek to tax part of the growth as employment income rather than capital gain. The fix costs nothing beyond fourteen days of attention at the outset. Missing it can cost the difference between an 18% BADR rate and a 45% (or 48% Scottish) income tax rate on a meaningful slice of an exit that may be years away.
Worked Example: Two Structures, the Same Underlying Value
A finance director is offered equity worth £200,000 of eventual value in a private trading company, three years before an anticipated exit. The comparison below assumes a Scottish additional-rate taxpayer for the option route, and full BADR availability for the growth share route.
Unapproved option | Growth shares (with valid s.431 election) | |
Tax at grant/acquisition | None | None (shares acquired at full low market value) |
Tax at exercise/vesting | Income tax and NIC on full spread at exercise, at up to 48% (Scottish) plus employee NIC | None (no exercise event; shares already held) |
Tax on eventual exit gain | CGT only on growth after exercise (often minimal, since exercise is usually shortly before exit) | CGT on full growth above hurdle-adjusted acquisition cost, potentially at 18% BADR rate |
Approximate effective rate on the £200,000 | Close to 48% plus NIC, since most of the value crystallises as income at exercise | As low as 18%, subject to BADR conditions being met |
The gap in this example is not a matter of aggressive planning. It reflects two structures that HMRC has always accepted as legitimate, taxed according to their genuine legal character. The point of this comparison is not that growth shares are automatically superior, since they carry real complexity, valuation risk, and a genuine cost in legal fees to structure a new share class correctly, but that the choice between the two routes should be made deliberately, with the tax consequence understood in advance, rather than defaulted into because "an option scheme" sounded like the obvious answer.
What the Employer Gets Back: Corporation Tax Relief
This point is worth including because it is genuinely underused. Where an amount counts as employment income on the exercise of an unapproved option (or on the acquisition of restricted shares where a section 431 election has been made), the employing company can usually claim a statutory corporation tax deduction under Part 12 of the Corporation Tax Act 2009, broadly equal to the amount charged to income tax. On a substantial exercise gain around an exit, this can meaningfully reduce the employer's corporation tax bill in the relevant accounting period, and it is a relief that has to be actively identified and claimed rather than one that appears automatically in most accounting software.
Unapproved Share Options vs Growth Shares: Where Income Tax Ends and CGT Begins
This interactive explainer helps UK taxpayers, founders and finance directors understand the crucial tax differences between unapproved share options and growth shares. It shows how unapproved options are taxed as employment income (plus National Insurance) on exercise at rates of up to 45% or 48% in Scotland, while correctly structured growth shares can shift the bulk of the gain into Capital Gains Tax, potentially at the 18% Business Asset Disposal Relief rate. Use the tabs to explore each structure, compare tax outcomes with the interactive charts and calculator (adjusting for residence and BADR), review key rules such as the 14-day section 431 election, and work through the practical checklist. The widget is designed for the 2026/27 tax year and provides clear, practical guidance without replacing professional advice.
Scotland and Wales: Where the Position Actually Diverges
The income tax charge on exercise of an unapproved option, and any income tax charge on acquisition of restricted shares without a valid section 431 election, is charged on non-savings, non-dividend income, which means Scottish taxpayers pay it at Scottish rates and bands rather than the rates applying in the rest of the UK.
For 2026/27, Scotland's income tax rates include a top rate of 48% above £125,140, three percentage points above the 45% additional rate that applies in England, Wales, and Northern Ireland, with a 42% higher rate applying considerably below the equivalent rest-of-UK threshold. A Scottish director exercising a large unapproved option in one tax year can face a materially higher income tax bill on exactly the same spread than an equivalent director in Manchester or Cardiff, purely because of residence, and this is worth modelling explicitly before choosing when to exercise, particularly where timing has any flexibility at all.
Capital Gains Tax, by contrast, including BADR, is reserved to Westminster and applies identically regardless of where in the UK the individual is resident. This creates a genuine asymmetry worth building into planning: the income tax portion of an unapproved option gain is exposed to Scottish divergence, while the capital gain on growth shares, or on post-exercise growth in an unapproved option, is not. Wales has no separate income tax rates for non-savings, non-dividend income at present, since the Welsh rates set by the Senedd have consistently mirrored the rest-of-UK bands, so no separate modelling is needed for Welsh-resident option holders beyond the standard UK position.
Practical Checklist Before Granting or Exercising
Confirm EMI eligibility before defaulting to unapproved options, particularly if the company's size has changed recently given the EMI limits expanding from 6 April 2026.
Get a proper valuation for growth shares at issue, ideally with contemporaneous documentation of the hurdle calculation, rather than a round number chosen for administrative convenience.
Diarise the section 431 election for fourteen days after any restricted share acquisition, and treat it as a default step rather than an optional extra, even where no tax appears to be due at that point.
Model the RCA position before exercise, since it determines whether PAYE and employee NIC apply immediately or whether the gain is simply reported via Self Assessment.
Agree employer's NIC recovery terms in the option documentation itself, not after the exercise has already happened.
Check the corporation tax deduction is actually claimed in the accounting period the income tax charge arises, since it is not automatic.
Model exercise timing against Scottish or rest-of-UK residence where the option holder is, or might become, Scottish resident, given the income tax portion of the gain is directly affected while the capital gain portion is not.
FAQs
Do I pay tax when my unapproved share options are granted, or only when I exercise them?
Generally only on exercise. There is normally no income tax charge on the grant of an unapproved option; the charge arises under section 476 ITEPA 2003 when the option is exercised, based on the market value of the shares at that point less what you paid.
Can I avoid income tax on an unapproved option by holding it for a long time before exercising?
No. Unlike some capital assets, the length of time an unapproved option is held before exercise does not convert any of the exercise gain into a capital gain. The entire spread at exercise is taxed as employment income regardless of how long the option existed beforehand.
What is the difference between growth shares and share options for tax purposes?
Share options give a future right to acquire shares, with income tax charged on the spread at exercise. Growth shares are actual shares acquired now at a genuinely low value because they only participate in value above a hurdle, so if valued correctly there is little income tax at acquisition and the growth is taxed as a capital gain on eventual sale.
Why does the section 431 election matter if there's no tax due when I get my growth shares?
Without a valid election, HMRC can potentially tax future increases in value attributable to restrictions being lifted, such as a forfeiture condition falling away, as income rather than capital gain. The election, signed within 14 days of acquisition, removes that risk by fixing the position at acquisition using the shares' unrestricted value.
Do I pay National Insurance on unapproved share option gains?
It depends on whether the shares are a "readily convertible asset" at the point of exercise. If they are, both employee and employer Class 1 National Insurance contributions apply alongside income tax. If they are not, typically the case for shares in a private company with no trading market, National Insurance is not due through payroll at that point, though it can arise later depending on how and when the shares are eventually sold.
Can I get Business Asset Disposal Relief on growth shares?
Potentially, yes, provided the usual conditions are met: a minimum two-year holding period, at least 5% of the ordinary share capital and voting rights, and the company being your personal trading company throughout. If those conditions are satisfied, gains on growth shares can qualify for the 18% BADR rate for 2026/27, up to the £1 million lifetime limit.
Does it matter whether I'm a Scottish taxpayer when exercising unapproved options?
Yes, for the income tax element. The exercise gain is taxed as non-savings, non-dividend income, so Scottish taxpayers pay it at Scottish rates, including a 48% top rate for 2026/27, which is higher than the equivalent 45% rate elsewhere in the UK. Any subsequent capital gain is unaffected, since Capital Gains Tax is reserved and applies at the same rate throughout the UK.
Why would my company use unapproved options instead of EMI?
Usually because the company or the individual does not meet EMI's qualifying conditions: an excluded trade, a company too large under the size limits, a non-employee such as a consultant or non-executive director, or an individual already at the £250,000 EMI limit. EMI's size limits expanded significantly from 6 April 2026, so it is worth rechecking eligibility if unapproved options were used specifically because the company had previously grown out of EMI.
Can my company claim any tax relief when I exercise an unapproved option?
Usually yes. Where an amount counts as employment income on exercise, the employer can generally claim a statutory corporation tax deduction under Part 12 of the Corporation Tax Act 2009, broadly matching the amount charged to income tax, though this deduction has to be actively identified and claimed in the relevant accounting period.
About the Author:
Adil Akhtar, ACMA, CGMA, FCMA (membership ID is 990250923) serves as CEO and Chief Accountant at Pro Tax Accountant, bringing over 18 years of expertise in tackling intricate tax issues. As a respected tax blog writer, Adil has spent more than eighteen years delivering clear, practical advice to UK taxpayers. He also leads Advantax Accountants (registered with Companies House), combining technical expertise with a passion for simplifying complex financial concepts, establishing himself as a trusted voice in tax education.
Email: adilacma@icloud.com
Disclaimer: This article sets out the general position under UK tax law for the 2026/27 tax year. The information has been checked against HMRC guidance and other official sources at the date shown above, and is reviewed when the rules change. Tax legislation is complex and outcomes depend on your individual circumstances, so this article is provided for general information and does not constitute advice on which you should act. Any figures or worked examples are illustrative. Before making any decision, obtain advice specific to your situation from a qualified professional. Pro Tax Accountant accepts no liability for loss arising from reliance on this article alone.
.png)