Share option schemes are designed for employees to not only give them right to acquire shares within their company but also provide them with various tax benefits. One of them is Enterprise Management Incentives (EMIs) scheme – This scheme is especially used by start-ups and small-businesses where cash is usually tight, and the share options could be offered to selected or key employees on the basis of their performance or to retain them or upon sale of the company.
Enterprise Management Incentives
EMI is a scheme specifically designed for small and medium enterprises in which qualifying companies grant share options to selected or key employees as reward for their efforts or to retain them in the organisation. Under the scheme, the company will grant share options to an employee. The shareoptions will give the employee the right to acquire shares within a specified period at a fixed price. In order to qualify for favourable tax treatment, the options have to be exercised within 10 years of grant. In most instances there will be no tax on the exercise of the option and the sale of shares by the employee will be subject to much favourable Capital Gains Tax (CGT) regime. If an employee has the right to buy shares for less than their market value at the date of grant, there will be an income tax charge when the options are exercised.
This scheme is approved by HMRC and the company will register the scheme and notify the details of the option agreement to HMRC within 92 days. There are some qualifying conditions for both employer and employees that need to be met in order to qualify for this scheme. This scheme has numerous tax benefits and proves beneficial for both employers and employees.
Qualifying conditions for employer’s
There are certain conditions that employers need to meet in order to qualify for Enterprise management incentive scheme (EMI) –
- The company must have a permanent establishment in UK.
- The company must be a trading company and not an investment company.
- The company must be carrying on a qualifying trade and all trades will usually qualify unless they are strictly prohibited or excluded. Financial, legal, farming, property development and certain other trades are specifically excluded from EMIs.
- The value of the total gross assets of the company must not exceed £30 million.
- The company must have less than 250 employees at the date of granting EMI options.
- The total value of shares over which EMI options are held cannot exceed £3 million.
- The company must not be a subsidiary or in control of any other company. However, parent companies are eligible to qualify for EMI.
Also See: Tax Rates and Allowances for 2020/21
Qualifying conditions for employee’s
There are certain conditions that employees need to meet in order to qualify for EMI –
- The individual must be an employee of the company that is issuing the shares or employee of a subsidiary including directors.
- The employee of the company must not hold a material interest in the company i.e. more than 30% of the company’s share capital.
- The employee or the director of the company must be working full-time or are required to work at least 25 hours weekly or 75% of their total working time(whichever is lower) in order to be eligible for EMI.
There are certain conditions for options in order to qualify for EMI –
- The shares must be ordinary and non-redeemable.
- Share options must be exercised within the tenure of 10 years from the date they are granted.
- The market value of the share options per employee must not exceed £250,000 (£30,000 in CSOP) at the grant date. In case the market value of share options gets exceeded, it will be considered as unapproved share options and will fall outside this scheme.
- All the terms and conditions of the options must be in a written agreement between the company and the employee and also prohibits the holder of the option to transfer their rights.
Tax implications of EMI for employers
- Qualifying companies offering EMI share option scheme to its employees are eligible for corporation tax relief in case when shares are acquired by employees upon the exercise of EMI options. Corporation tax relief is given on the difference between the value paid by the employees to acquire the shares and value when the shares are exercised by the employee.
- If EMI options are granted to employees at the market value, corporation tax relief will be equal to the amount that would have been charged to tax and you can save the received EMI relief.
- If EMI options are granted to employees at a discount to market value, corporation tax relief will be provided for both the discount amount and amount that would have been charged to tax and you can save the received EMI relief.
Also See: Gifting shares to employees
Tax implications of EMI for employees
- When option is granted – When the initial grant of EMI options is accepted by the employee, employee is not liable to pay income tax and national insurance contributions. The exercise price of the options decides that whether employee is liable to pay Income tax and National Insurance contributions or not.
- When option is exercised – There may be three stages when option is exercised by the employee –
- When the exercise price is equal to or more than the market value of the shares at the time when they are initially awarded, employee is not liable to pay income tax or national insurance contribution on its sale.
- When the exercise price is less than the market value of the shares at the time when they were initially awarded and shares are still not readily convertible assets, only income tax is chargeable on the difference between the actual market value at the date when the option was granted and the exercise price.
- When the exercise price is less than the market value of the share at the time when they are initially awarded and shares have become readily convertible assets, it is subjected to PAYE and both income tax and Class 1 national insurance contributions on the difference between the actual market value and the exercise price.
- When shares are sold – When shares are sold, capital gains tax must be paid at the time of sale. The capital gains tax in a normal scenario is 20% whereas under EMI option, it is chargeable at 10% if the employee meets the Business Asset Disposal Relief (previously entrepreneur’s relief) condition. For the purpose of EMI, an employee does not need to hold 5% stake in the company to qualify for Business Asset Disposal Relief, rest all conditions need to be met.
Tax Benefits of EMI
Case Study 1 – Comparing EMI with non-tax advantaged scheme
Non-tax advantaged option scheme
Mary is an employee of a tech firm and has been granted 3% shareholding in her employer’s company, the market value of which is £10,000. She exercises the option when the values of the shares become £100,000 after 4 years. After 2 years, she sells the shares at £150,000, when the company is taken over by someone.
When the option is granted, there is no tax paid by Mary but at the time of exercise, she is having taxable earnings of £90,000 (£100,000 - £10,000). She has not received any cash yet, but still ends up paying the income tax of £40,500, at her marginal rate of tax – 45%. At the time of sale, Mary pays capital gains tax on £50,000 growth in shares value since she acquired it. Due to no relief available, she will be charged tax @20% of £10,000, ignoring the annual exemption relief.
Hence, Mary acquired the shares for £10,000 and sold it on the price of £150,000. She has to pay tax of up to £50,500. From this example, it is cleared that most of the amount is payable in Tax by Mary before she receives any money and didn’t get any tax benefit or reliefs.
Considering the same example, in the case of EMI, when the option is granted and exercised, there is no tax paid by Mary. At the time of sale, Mary pays capital gains tax on the gain of £140,000 (£150,000 - £10,000), as she qualifies for business asset disposal relief, she will be charged tax @10% of £140,000 i.e. £14000, ignoring the annual exemption relief.
Hence, Mary here saved an approximate tax of £40,000 because of EMI scheme and paid no tax till she received any money. She gets a huge benefit and saved much of her tax because of EMI scheme. Therefore, we can say that Mary has taken a good step by preferring EMI scheme over non-tax advantaged option scheme.
Case Study 2 – EMI Options vs Bonus
Let’s consider another example where a company wants to reward a director of the company after 5 years. The director is a higher rate payer (45% tax) and is given options in the company when the actual market value of the shares on the date of grant is £10,000. After 5 years, the value of the shares increases to £500,000 and the director does not pay any money to acquire the shares on the exercise date.
|Cash bonus||EMI Option|
|A||Gross value received by the director||£500,000||£500,000|
|B||Taxable employment income||£500,000||£10,000|
|C||Income tax and EE NIC (B @ (45% + 2%))||£235,000||£4,700|
|D||Value subject to CGT (A - B)||£0||£490,000|
|E||CGT at 10% (D @ 10%)||-||£49,000|
|F||Total employee taxes (C + E)||£235,000||£53,700|
|G||Net Value to employee (A-F)||£265,000||£446,300|
|H||Employer NIC (B @ 13.8%)||£69,000||£1,380|
|I||Employer CT Relief (A+H) *19%||£108,110||£95,262|
|J||Total Cost to Employer (A+H-I)||£460,890||£406,118|
With the EMI option the director receives the maximum benefit and the cost of providing the benefit for the employer is also lower.
Hence, EMI are great tool for rewarding employees and making them part of the organisation’s growth.
A number of changes or development in the company or employee’s situation can disqualify an option from the EMI scheme. These are called “disqualifying events” and include the following:
- If the company becomes a subsidiary of another company.
- If the company ceases to meet qualifying trading activities.
- If the employee ceases to be an eligible employee.
- If there is alteration in the terms of the option.
- If there is alteration to the company’s share capital.
- If there is share conversion from one class to another.
If an EMI option is exercised within 90 days of the disqualifying event, the event will have no effect and the tax advantages will be preserved. When the option is exercised later, it is subjected to income tax as well as PAYE and national insurance contributions (If the shares are readily convertible assets at the time of exercise).
How DNS can help?
DNS Accountants has been advising companies for a number of years on Enterprise management incentive scheme. Our enterprise management incentive scheme includes –
- Advanced assurance from HMRC that the company is eligible for EMI Code.
- Designing of your EMI scheme.
- Draft up legal documents and board minutes and agree the terms of the option.
- Drafting employee guides and helping you communicate this to employees.
- Valuation of the employee shares.
- Compliance with HMRC and Companies House.
- Assistance in preparing and filing of EMI option scheme annual returns.
- Accounting advice.
For more information, please contact us 03300 88 66 86 or email us on firstname.lastname@example.org
Also See: Tax advantaged employee share schemes