Employee Share Schemes
Enterprise Management Incentives (EMI) Share Option Schemes are a type of employee incentive scheme that can enjoy very favourable tax treatment if introduced and operated correctly. They are the most popular HMRC tax favoured scheme used by businesses in the UK. EMI Share Option Schemes are specifically designed for small companies and they are a great way for businesses to attract or retain talented staff who may not be able to afford the high salaries that such staff could command elsewhere. Nowadays, many highly qualified staff, in particular in the tech sector, are expecting to be offered shares as part of their remuneration.
Essentially, EMI Share Option Schemes reward employees (usually key employees) with equity participation in a company. An overview of the qualification criteria for operating a scheme is set out below but please note this is subject to change. In the Spring 2020 Budget (paragraph 2.200), the government announced that it will review the EMI legislation to see how effectively it meets the objective of enabling smaller companies to recruit and retain staff. This may lead to a relaxation of the qualification criteria to enable more companies to benefit.
Which companies can operate EMI Share Option Schemes?
In summary, for a company to qualify to grant EMI options, the following conditions must be met:
- The company must be independent (i.e. not a 51% subsidiary of any other company or under the control of another company / another company and a person connected with it and there are no arrangements in place under which these conditions would not be met).
- If the company has any subsidiaries they are “qualifying” subsidiaries (i.e. the company owns at least 51% of the subsidiary, the subsidiary is not under the control of someone else and there are no arrangements in place under which these conditions would not be met). Additional requirements apply to property managing subsidiaries.
- The company’s gross assets are no more than £30 million at the time of grant.
- The company must have fewer than the equivalent of 250 full-time employees.
- The company must be a trading company, or the parent company of a trading group with a qualifying trade which does not involve an excluded trading activity.
- The company must have a UK permanent establishment.
Please note that detailed statutory rules determine whether a company is able to satisfy these requirements, and specialist advice on this is recommended before setting up an EMI scheme. Companies can also seek clearance from HMRC that they meet these requirements.
What shares can EMI options be granted over?
EMI options can be satisfied by newly issued shares or by the transfer of existing shares from a shareholder, including an employee benefit trust (EBT). The shares must meet certain requirements, including that the shares must be fully paid up, non-redeemable ordinary shares.
Who can be granted EMI options?
To be eligible to be granted an EMI option, an employee must work for the company for at least 25 hours per week, or if less, 75% of their working time. Employees cannot be granted EMI options if they (or their “associates”) have a “material interest” in the company whose shares are used for the scheme, or in certain related companies.
Setting the exercise price and valuing the shares in EMI Share Options Schemes
The exercise price of an EMI option can potentially be set at any level (including nil). Options are usually granted at a price equal to the market value at the time the options are granted in order to prevent any income tax or national insurance contributions charges arising on exercise. HMRC will agree share valuations in advance of the grant of EMI Share Options and will usually agree a valuation window of 90 days during which the option may be granted (although it is currently offering windows of 120 days during the COVID pandemic).
Limits on EMI options
An employee can hold unexercised EMI options over shares worth up to the current EMI individual limit (£250,000). A company cannot have granted outstanding EMI options over more than £3 million worth of shares at any one time.
When can an EMI option be exercised?
The EMI code requires that EMI options must be capable of being exercised within ten years of the date of grant, and options can only be exercised within a period of 12 months after the option holder’s death. Otherwise, there are few restrictions on the exercise provisions that can apply to EMI options, and this flexibility means that they can be used for exit-only arrangements (where an option can only be exercised on an exit event, such as a share sale or listing), as well as for options exercisable at the end of a performance or vesting period.
When do EMI options lapse?
Apart from the legislative requirements for the exercise of EMI options referred to above, there are no restrictions on when EMI options can be exercised or will lapse. However, it is best practice for EMI option agreements to specify exactly when options will lapse, particularly at the end of a window period for exercise. Often, the EMI option agreement will provide that options will lapse on leaving employment, although early exercise may be permitted in certain circumstances.
The EMI option agreement will generally also provide that options lapse if the option holder becomes bankrupt, and it must also prohibit an option holder from assigning the options or using them as security.
Tax treatment for the company
A corporation tax deduction may be available when EMI options are exercised (under Part 12 of the Corporation Tax Act 2009). Relief is given in the accounting year in which the options are exercised and should be claimed by the option holder’s employer company (not the company whose shares are acquired, if different). The deduction is equal to the gain the employee makes.
Tax treatment for the employee
The EMI option plan must be registered with HMRC who will allocate a unique scheme reference number about a week later. In order for an EMI option to qualify for favourable tax treatment, the grant of each option must also be notified to HMRC within 92 days of the grant date, using the ERS Online Service.
In practice, it is not possible to notify the grant until HMRC has allocated a scheme reference number, so it is important to do this well before the 92 day period expires. If the option remains a qualifying EMI option (no disqualifying event has taken place before exercise), the tax treatment for an employee holding an EMI option is as follows:
- On grant – there is no income tax liability on the grant of the option.
- On exercise – there is no income tax liability on exercise if the exercise price was at least equal to the market value of the shares at grant. If the exercise price was less than the market value of the shares at grant, then income tax is due on the difference between the exercise price and the market value at grant.
- On disposal – on a sale of the option shares, capital gains tax(CGT) may be payable on any gain over the market value at grant (that is, the difference between the sales proceeds and the market value of the shares at grant). Importantly, provided that at least 2 years have passed since the option was granted and all other statutory requirements are met, CGT business asset disposal relief (previously referred to as entrepreneurs’ relief) will be available.
Disqualifying Events Under EMI Share Option Schemes
The EMI rules refer to certain “disqualifying events” which, if they occur, can impact on the tax treatment of the EMI option affected.
Disqualifying events include:
- the company ceasing to satisfy the independence test;
- the company ceasing to meet the trading activities test;
- the employee ceasing to be an eligible employee because:
- they cease to work for the relevant company or within the group; or
- they cease to satisfy the working time commitment;
- certain alterations to the option:
- certain alterations to the share capital of the company; and
- the grant of options under a CSOP which would (when added to unexercised EMI options) take the aggregate market value of the shares subject to such options (measured at the date of grant) to over £250,000.
EMI Share Option Schemes – National Insurance Contributions
Broadly, the NICs treatment of EMI options follows the income tax treatment:
- There will be no NICs if no income tax is due.
- There will be NICs if income tax is payable and the shares are readily convertible assets.
The employer and the employee may enter into arrangements under which the employer NICs liability is transferred to the employee
EMI Share Option Schemes – traps for the unwary
Although EMI Share Option Schemes can be set up fairly quickly and for some companies it will simply be a question of following a set process, we see many examples of schemes gone wrong.
In particular, the EMI option agreement must be drafted with care in order to comply with all current HMRC requirements, including the detailed information that must be given to the option holder and the declarations that must be provided by them.
In circumstances where the scheme was not set up properly (for example because documents are not compliant or notifications weren’t made on time or full disclosure was not made to HMRC when agreeing share valuations) this will lead to unexpected income tax charges arising on exercise of the grant and other reliefs being lost. This can leave the employer with very disgruntled employees who will want to be compensated for the additional tax they are having to pay. It can also be a problem if the owners of the business intend to sell it and the errors are spotted by the lawyers acting for the buyer. Those lawyers will be advising the buyer that they should be reducing the purchase price for the business to cover the fallout.
Here to help
If you have any questions on EMI Share Option Schemes or need help putting such a scheme in place please contact Suzy Giele our expert EMI lawyer.