What are EMI option schemes?
Enterprise management incentive schemes are a tax-advantaged way of helping companies, particularly smaller companies with ambitions to grow, attract and retain key employees by rewarding them with equity participation in the business.
EMI option schemes provide employees with significant tax benefits and are more flexible than other tax-favoured share incentive arrangements, creating an opportunity to offer employees the option to purchase equity in the future at a fixed price.
Company and employee qualifying requirements
A number of requirements must be satisfied for a company and its employees to be eligible for EMI options, including:
Qualifying trade: the company must carry on a qualifying trade i.e. with a view to generating profit. HMRC maintains a list of ‘non-qualifying’ trading activities which include (but are not limited to): property development, leasing, farming, and financial activities.
Company size: at the time the EMI option is granted, the company (or the group it is part of) must not have gross assets which exceed £30 million and must have less than 250 full-time equivalent employees.
Independent company: the company granting EMI options must not be under the control of another company (although the parent company of a qualifying group can grant EMI options to group employees).
Fully paid-up shares: the shares offered must be fully paid-up ordinary shares that are not convertible or redeemable.
Working time: to qualify employees must be required to work at least 25 hours per week or spend at least 75% of their working time, for the company or another company within the group. Executive directors who satisfy the working time requirement can participate, but employees who have an interest in 30% or more of the group before the options are ineligible.
If the company or a participating employee stops meeting any of the eligibility requirements, the employee has 90 days to exercise their options. If they fail to do so, income tax and National Insurance contributions (NICs) may be chargeable on any increase in value between the date of the disqualifying event and the date the options are eventually exercised. Employees and companies should keep EMI qualifying requirements under review.
No income tax or NICs are chargeable at the date of grant of the EMI option. So long as the options were not granted at a discount to market price, EMI shares should also be exempt from income tax and NICs when the options are exercised. The tax benefits are therefore generous.
Capital Gains Tax (CGT) is payable on the sale of EMI option shares, which is charged on any increase in share value from the date of grant. If the EMI option shares are sold more than two years after the date of grant Business Asset Disposal Relief (BADR), which reduces the rate of CGT payable by the employee on the first £1 million of lifetime gains to 10%, may be available.
The company may also be able to claim corporate tax relief on the option gain – in the financial year that an employee exercises their EMI options, the employer should be able to deduct the value of the employee’s gain from their tax liability.
EMI option terms must be set out in a written agreement which must include details of any share restrictions (usually contained in the company’s articles of association). While there is flexibility over the length of the option period, employees must be able to exercise their options within 10 years of the date of grant.
Although EMI plans are not approved in advance by HMRC, the options must be reported electronically within 92 days of grant to secure the tax reliefs. We recommend that the market value of shares in unlisted companies is agreed in advance with HMRC.
Alternative share schemes
If an EMI option scheme is not available to a company, there are a number of different tax-advantaged and non-tax-advantaged share schemes which may be available and attractive for different reasons. For example, larger companies that do not qualify for EMI schemes often grant options under a Company Share Option Plan (CSOP) which means, provided statutory conditions are met, any gain on the exercise of options should be free from income tax and NICs.
If none of the usual tax-advantaged share schemes are available there are numerous types of non-tax-advantaged share schemes, which can be used to incentivise key employees but do not attract favourable tax treatment.