An UK employee only Enterprise Management Incentive (EMI) scheme is an approved employee share scheme that is available to most trading companies, allowing employers to grant share options to key employee’s tax efficiently, as a reward for their efforts within the business and/or to retain and incentivise key staff.
EMI was introduced in 2000, however, there have been a number of changes that have made the scheme even more attractive.
Being that EMI schemes are approved by HM Revenue and Customs (HMRC) there are various conditions that must be met by the employer, employee and the options themselves. These conditions are not particularly difficult to meet or exhaustive but the tax advantages that can be obtained can be very beneficial to both parties involved.
My blog tries to explain and make clear the qualifying requirements for an EMI scheme, the tax advantages that can arise from an EMI scheme and the recent beneficial changes.
Broadly, the following conditions must be met by the company –
- The total value of the company’s gross assets must not exceed £30 million.
- The company must be a trading company (i.e. not an investment company).
- The company must not be a subsidiary of or controlled by another company, however, parent companies can qualify for EMI.
- There must be fewer than 250 employees at the date the EMI options are granted.
The following conditions must be met by the employee –
- The individual must be an employee of the issuing company, or an employee of a subsidiary (directors included).
- Employees are required to spend at least 25 hours per week or, at least 75% of their working time, as an employee of the company.
- The employee must not hold more than 30% of the shares of the company.
The following conditions must be met as regards to the share options –
- The shares must be ordinary, non-redeemable shares.
- The options must be exercisable within 10 years of grant.
The market value of the option (including all other share options) must not exceed £250,000 per employee, at the date of grant. Any options which exceed this limit will be unapproved share options and will fall out of the EMI regime.
The terms of the option must be agreed in writing and must prohibit the option holder from transferring their rights. All other terms and conditions, such as the trigger point allowing employees to exercise their options, are flexible and therefore can be decided by the company.
Generally, if an employer rewards an employee with unapproved shares, Income Tax and National Insurance Contributions will be charged on the difference between the market value of the shares and any amount paid towards them, in the same way as a salary or bonus.
If, however, EMI options are granted at market value there will be no charge to Income Tax or National Insurance Contributions at either grant or exercise of the options. Prior agreement of the value of the company shares at grant can be obtained from HMRC.
For example, if the value of the shares has increased substantially at the date of exercise, the employee will only be required to pay the agreed market value at the date of grant, satisfying this condition and ensuring that no Income Tax charge will arise. Once the options have been exercised, any subsequent disposal of the EMI shares will fall within the Capital Gains Tax regime and therefore any uplift in the value of the shares will be subject to the lower rates of Capital Gains Tax (in comparison to Income Tax rates of 20%, 40% and/or 45%/50%).
Importantly for the employer company, upon exercise of the options, the company can usually claim a Corporation Tax deduction equalling the market value of the shares at exercise less the amount paid by the employees. The employer also benefits from National Insurance Contributions not being payable.
In order for the employer to ensure that options granted will qualify under the EMI scheme, the company can obtain prior clearance from HMRC confirming; (i) that the employer is a qualifying company, and; (ii) what the market value of the shares is at the date of grant.
It is also necessary to notify HMRC once the aforementioned options have been granted within certain time limits. If these deadlines are missed the options granted will not qualify under the EMI scheme and thus will be deemed unapproved share options.
Changes Since Inception
There have been important tax changes introduced in respect of EMI schemes.
Firstly, the total value of options available to grant per employee was increased from £120,000 to £250,000 from 16 June 2012.
Secondly, the rules surrounding Entrepreneur’s Relief (ER) will be relaxed in relation to the disposal of EMI shares after 6 April 2013. ER is a specific Capital Gains Tax relief whereby individuals who dispose of business assets can qualify for a reduced Capital Gains Tax rate of 10% (lifetime limit of £10,000,000). As regards to trading company share disposals, the current conditions that must be met in order to obtain ER are that the individual must hold at least 5% of the issued share capital, for at least 12 months, as well as being an employee of the company at the time of disposal. EMI share holders will often fail to meet the 5% and 12 month conditions and thus employees who dispose of EMI shares often don’t qualify for ER.
However, the changes from 6 April 2013 will mean that, in relation to EMI shares only:
The 5% ownership requirement will be removed. Therefore EMI share option holders can be entitled to ER regardless of how many shares they hold and the 12 month ownership period will commence upon grant of the options instead of upon exercise of the options, as was the case previously.
An EMI scheme may be attractive to companies who wish to:
- Align employees interests with the company’s
- Reward, motivate and incentivise key staff
- Retain key staff for the medium to long term and
- Promote share ownership in the company in a tax efficient manner.
Due to the favourable tax treatment of EMI schemes it is possible for an employee to receive shares free of Income Tax and National Insurance Contributions and then potentially only pay Capital Gains Tax at 10% upon disposal of their shares, if the conditions for ER are met.
The EMI scheme has always been an efficient way for company’s to offer shares to incentivise and/or retain key staff and now that some of the old limitations to the tax rules have been removed or relaxed to improve the tax position further, an EMI scheme provides an even more effective and attractive solution for many small and medium sized companies.