An Enterprise Management Incentive (EMI) option gives eligible employees the right to buy shares at a price fixed today, with capital gains tax treatment on any gain at exercise — provided your company meets the qualifying conditions under Schedule 5 of the Income Tax (Earnings and Pensions) Act 2003 and you notify HMRC of the options by 6 July following the end of the tax year in which they were granted. Miss that deadline or fail one qualifying test and the tax advantage disappears, turning what looked like an equity incentive into a taxable employment income event.
Who can use EMI — and who is excluded
EMI is available only to independent trading companies. The key thresholds under ITEPA 2003 Sch 5, as amended by the Finance Act 2026 with effect from 6 April 2026, are: gross assets not exceeding £120 million at the date of grant, and a headcount of fewer than 500 full-time equivalent employees. Both tests apply at the moment each option is granted, not at incorporation or a funding round.
"Trading company" is the harder test in practice. A company that derives a substantial part of its activities from holding investments, property development, financial services, or other "excluded activities" in Sch 5 para 16 will fail — even if it also runs a genuine trade. HMRC treats "substantial" as roughly 20% of turnover, assets, or management time, though the line is imprecise, and companies with mixed income often need a pre-grant advance assurance request.
The company must also be independent — not a 51% subsidiary of or controlled by another company. Group structures where a parent wishes to grant EMI options in an operating subsidiary require careful review: EMI sits at subsidiary level, but the independence test spans the group.
The employee qualifying conditions
Not every employee can hold EMI options. Under Sch 5 paras 26–28, the optionholder must be a bona fide employee or director who works for the company (or a qualifying subsidiary) for at least 25 hours per week, or — if less — at least 75% of their working time. That excludes advisers, consultants, and non-executive directors who are not also employees, even if they hold options in good faith.
A material interest restriction also applies: the employee must not hold (directly or through associates) more than 30% of the ordinary share capital at the date of grant. Founders with large retained stakes sometimes fall foul of this on a later grant round. Each optionholder can hold options over shares worth up to £250,000 (measured at grant), subject to a company-wide cap of £6 million outstanding at any time — increased from £3 million by the Finance Act 2026 for options granted on or after 6 April 2026.
HMRC valuation agreement — do it before you grant
The exercise price in an EMI option is typically set at the unrestricted market value (UMV) of the shares on the date of grant. Getting that valuation wrong is the single most common error. If HMRC later disagrees and determines the exercise price was below market value, the discount is treated as employment income at grant — taxable under PAYE and subject to National Insurance.
The practical fix is to request an advance HMRC valuation agreement through the Shares and Assets Valuation team before the grant date. HMRC will agree a UMV figure binding for EMI purposes, provided options are granted within 90 days of that valuation date. For early-stage companies without traded shares, the methodology usually turns on net asset value, discounted cash flow, or a comparable transaction. Many founders set exercise prices at a modest discount to a recent funding round price by applying an agreed minority and illiquidity discount.
Without the agreement, the company carries valuation risk indefinitely. If the company is acquired or lists, HMRC has wide powers to challenge historic valuations, and re-characterising option gains as employment income — including employer NIC — is costly.
Disqualifying events and the 90-day notification window
A disqualifying event ends the tax-advantaged status of an EMI option. Common disqualifying events under ITEPA 2003 ss.534–536 include: the company ceasing to be an independent trading company, the optionholder ceasing to meet the working time requirement, and the company falling outside the gross assets or headcount thresholds.
When a disqualifying event occurs, the optionholder has 90 days to exercise the option and still retain EMI tax treatment — that is, capital gains tax on the full gain from the original grant price, subject to Business Asset Disposal Relief (which reduces the effective CGT rate to 18% on gains up to the lifetime allowance of £1 million). After those 90 days, any gain on exercise is split: the growth from grant to disqualifying event remains capital, but the growth from the disqualifying event to exercise becomes employment income taxable at marginal rates.
Acquisition is the most frequent disqualifying event startups encounter. A change of control triggers it at completion, so founders commonly build an exercise mechanism into the option deed tied to drag-along provisions, allowing exercise immediately before completion and keeping all value within the favourable CGT period.
What the EMI option deed must include
HMRC sets out the mandatory content requirements in Sch 5 paras 37–43. An EMI option deed that omits required provisions is simply not a qualifying option — the tax advantage never arises regardless of intent.
Required provisions include:
Specified shares. The deed must identify the class of shares subject to the option. Ordinary shares in a private company are the standard; the shares must be fully paid-up, non-redeemable, and not subject to any restrictions that would impair their marketability to a material degree (unless any such restrictions are expressly set out in the deed).
Exercise price. The agreed price per share, fixed at grant. It can be set at any level — including nil-cost for so-called "nil-cost options" — but the tax treatment at exercise depends on whether the price equals, exceeds, or falls below UMV at grant.
Exercise conditions. The conditions on which the option becomes exercisable — vesting schedule, performance targets, or good/bad leaver provisions. These are commercially negotiable but must be stated clearly. A typical structure is a 12-month cliff then monthly vesting over three years, with exit-linked acceleration.
Restrictions on shares. Any lock-up, right of first refusal, tag-along or drag-along right attaching to the shares must be described in the deed or in a shareholders' agreement identified in the deed. HMRC requires that the optionholder is aware of all restrictions before grant.
Details of the company and optionholder. Full legal name, registered office, and company number for the company; full name and national insurance number for the employee.
For a structured starting point when drafting these provisions, the UK share option agreement template at forms-legal.com covers the mandatory Sch 5 fields and standard vesting mechanics.
Anti-dilution and the exercise price
EMI option deeds routinely include an anti-dilution provision adjusting the number of shares or the exercise price on a capitalisation, consolidation, or subdivision of the company's share capital. These adjustments are permitted under Sch 5 para 37(2) provided they do not materially increase the value of the option.
What EMI does not protect against is economic dilution from new equity issuance. If the company raises a Series A at a higher valuation and issues new shares, existing option holders' percentage ownership falls — the exercise price does not adjust automatically. Some option deeds include a weighted-average anti-dilution formula or a ratchet tied to exit proceeds, but these are negotiated features, not required by Sch 5.
The interplay between anti-dilution and EMI status needs careful attention. Certain amendments to an EMI option — including a material reduction in the exercise price — are treated by HMRC as a new option grant, resetting the grant date and triggering a fresh notification obligation for the new tax year.
Notification to HMRC — the deadline on grant
For EMI options granted on or after 6 April 2024, the company must notify HMRC of each option through the Employment Related Securities (ERS) online service by 6 July following the end of the tax year in which the grant was made. For example, an option granted in December 2025 must be notified by 6 July 2026. Late notification means the option is not a qualifying EMI option, full stop — HMRC has no power to grant relief outside very narrow error provisions.
Notification requires: each optionholder's details, the number and class of shares, the exercise price, the market value at grant, and a declaration of qualifying status. Without an advance valuation agreement, the company must submit its own valuation at this stage, which HMRC may challenge.
Annual reporting is also required by 6 July each year via ERS, covering grants, exercises, lapses, and amendments in the preceding tax year. Failing to file the annual return risks the scheme being treated as non-qualifying retrospectively.
Practical checklist before granting
Before the board approves a grant, confirm: gross assets below £120 million (check last management accounts); headcount below 500 FTE; the company qualifies as an independent trading company with no material excluded activities; each optionholder works at least 25 hours per week; an HMRC valuation agreement is in place or a defensible methodology is documented; the deed contains all Sch 5 mandatory content; and notification will be filed via the ERS online service by 6 July following the end of the tax year of grant.
EMI is one of the most tax-efficient equity incentive tools available to UK startups, but the conditions are technical and non-compliance is irreversible. A grant that looks valid at signing can fail on any one of a dozen criteria — and the employee, not the company, bears the resulting income tax cost.
Need the document itself? Download the free template →
This article is general information, not legal advice — see our accuracy & editorial policy. Confirm the cited law is current before relying on it.