Employee share schemes, less “tax-without-cash” for unlisted companies

By Handan Siyahdemir and Stephen Walker

“Tax-without-cash” is an issue that arises in several areas of our tax system, but thanks to a new set of tax rules, this issue can be solved for employees in unlisted companies receiving shares, where Employee Share Scheme (ESS) income can arise before the employee has any real ability to sell their shares and fund the tax. From 1 April 2026, the new Employee Deferred Shares (EDS) regime is intended to narrow that gap by deferring the employee taxing point until a defined liquidity event, bringing the tax outcome closer to when cash is available.

The draft rules for the EDS regime were introduced last year and have now been finalised. This article summarises some of the key changes between the original proposals and where the rules have now ended up in enacted form.

From 1 April 2026, unlisted companies can designate certain ESS shares or options as EDS. To use the EDS regime, the shares still need to meet the ESS eligibility settings (i.e. being shares in an unlisted company and falling within the ESS rules), and the employer must make an active declaration notifying both Inland Revenue and the employee within 20 days of issuing or transferring the shares to the employee.  The employee’s taxing point is deferred until 20 days after a “liquidity event date”. The employer’s corporate tax deduction is also deferred, keeping the employee income and employer deduction broadly aligned. These core settings are unchanged.

However, the following key changes were incorporated into the final legislation (compared with the draft rules covered in our earlier article):

Dividends will not trigger a “liquidity event”

The final rules drop the declaration and payment of dividends from the liquidity event definition, which should reduce the risk of “tax-without-cash” outcomes in some scenarios where dividends wouldn’t cover the corresponding liquidity to satisfy the tax.  Inland Revenue has signalled it will monitor dividend behaviour, so using dividends to strip value ahead of a sale/listing may attract future tightening.

Paper liquidity is treated differently

A number of submissions on the draft legislation highlighted that a liquidity event should not accelerate tax where employees don’t receive (or become entitled to receive) a liquid asset, for example, certain restructures where the participants receive other illiquid shares in exchange for giving up designated EDS, or other events that have post transaction lockups and restrictions on sale.  Parliament agreed with these submissions and the final rules mean that a liquidity event should be limited to situations where participants have a means of liquidating their shares to satisfy their tax obligation.  Importantly, this means that if an employee has a right to liquidate their shares, even if they have vested but remain unexercised, this will still be considered a liquidity event that brings the shares out of the EDS rules.  In these cases, the ESS income will arise on exercise in the normal way under the standard ESS rules.

Designation is employer-led — but more flexible

Despite some submissions requesting greater flexibility around the ability for employees to designate their shares as EDS, Inland Revenue did not adopt this change. Officials were concerned that it would add complexity to the administration of these schemes, particularly in ensuring consistency in timing and amount of employee income and corporate tax deductions.  However, through the submission process Inland Revenue did make it clearer that the intention of the rules was to allow different ESS shares from the same issuance to be designated as either EDS or non-EDS (i.e. the employer would run too schemes in parallel).  The designation of shares as EDS is unlikely to be a unilateral decision made by the employer, and discussions with employees would be had in most cases before deciding to designate shares as EDS, which would mean, in practice, employees would be involved in the designation decision. 

Summary of the final rule

The new rule for deferring tax for unlisted employee share schemes requires:

• The company offering it is not listed, and nor is any other company in the group
• An employer makes a designation of shares as “employee deferred shares” and notifies the employee and Inland Revenue within 20 days after the date of issue or transfer
• The consequence is the that the share scheme taxing date for the shares is deferred to the “liquidity event date”, which is defined as the earliest of the following dates:
  • the date the issuing company becomes a listed company
  • the employee sells the shares to someone not associated with them
  • the date the shares are cancelled.

As highlighted in our previous article, the benefit of the EDS proposal is the deferral of the payment of the tax due by an employee to a future date (when the shares become liquid). The flipside however is that any increase in the share price, from the time the employees are provided with the shares and when they subsequently become liquid, will be taxable.

Key takeaways

We’re pleased to see a sensible approach has been adopted in the final rules, with dividends, lock-ups and non-cash restructures now falling outside the definition of a liquidity event. It is also helpful that the legislation clarifies, and clearer guidance that the employer designation is not an all or nothing election, with flexibility to choose which shares are EDS within the same issue. 

For unlisted companies, these rules provide practical optionality for structuring employee rewards. However, the core trade-offs remain and should be assessed before making an EDS designation.

In particular, employers and employees should weight:

1. Deferring the tax until there is cash available to pay it (and likely pay tax on a higher amount later on but with greater certainty that tax is being paid on something with real value), versus
2. Paying the tax earlier on a potentially lower amount using funds from other sources (but with the risk that tax is paid on a value that later turns out to be more than can be realised on eventual sale).

If you have any queries on ESS or the EDS regime please contact your usual Deloitte advisor.