EMI share option schemes – a form of remuneration to be considered now more than ever by companies and employees
For the purposes of this article, we shall be considering employee share option schemes only and will not be considering any employee direct ownership schemes, or employee trust ownership arrangements. Further information on these ownership structures can be provided if required.
Current issues
As many businesses suffer a dramatic and immediate drop in turnover caused by the Covid-19 outbreak, a business’ ability to retain staff may become a cause for concern. Typically, to retain staff, a company may increase the salary of an employee or offer, say, a cash bonus. In uncertain times, being able to offer a salary increase or a cash bonus may not be possible but, as set out below, a company may offer share option schemes as a means to ensure that a company’s key assets, its employees, are retained or recruited.
Why do companies use employee share option schemes?
The main reason for using employee share option schemes is to recruit, retain and motivate employees. They are also used to align the interests of the employees, particularly senior executives, with those of shareholders. The aim of this alignment is to encourage senior executives to consider the best interests of shareholders in their management of the business. Successive governments have taken a view that share ownership by employees is something positive and to be encouraged, tax legislation has therefore been introduced in connection with specific employee share schemes for these to enjoy valuable tax reliefs.
What employee share option schemes are available?
Employee share option schemes can be divided, generally, into two forms as set out below:
a) tax advantaged schemes; and
b) non-tax advantaged schemes.
There are four types of tax advantaged share option schemes available to companies. These are as follows:
a) enterprise management incentive schemes (EMI schemes);
b) company share option plans;
c) save as you earn schemes; and
d) share incentive plans.
The most popular tax advantaged employee share option scheme is the EMI scheme with approximately 85% of all tax advantaged employee share schemes being EMI schemes. Within a report published by HMRC on 18 June 2018, it was concluded that there is substantial evidence that EMI schemes are fulfilling their core aims of improving recruitment and retention prospects for small and medium enterprises and supporting their future growth. Given the popularity of tax advantaged option schemes, and the EMI scheme in particular, for the purposes of this article, we will concentrate our analysis and comment on EMI schemes only. We will also not be considering non-tax advantaged schemes at this time and they, with a concentration on growth shares, will be considered in a separate article.
What is an EMI scheme?
An EMI share option scheme is a type of share option granted to employees that enjoys favourable tax treatment. They are specifically targeted at small, higher-risk trading companies. EMI options take the form of a written agreement between the option holder (i.e. the employee) and the grantor (i.e. the employer company) which states the main terms of the EMI option, including how and when it may be exercised.
Which companies can grant EMI options?
To qualify to grant EMI options, a company must be an independent trading company with:
a) gross assets of no more than £30,000,000; and
b) fewer than the equivalent of 250 full-time employees.
A company’s trading activities are also relevant to its ability to implement an EMI scheme. For example, companies with the following trading activities as their main trading activity will not be eligible to grant EMI options to their employees:
a) property development;
b) legal and accounting services; and
c) banking, insurance, money-lending or other financial services.
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. Each share must be a fully paid up, ordinary share.
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 total working time. It is also worth noting that EMI options can only be granted to employees. They cannot be granted to, say, non-executive directors or consultants.
The current limit on the value of shares over which unexercised EMI options can be held by an individual employee is £250,000 (calculated as at the date of grant of the EMI option).
The current limit on the total value of all shares that may be subject to unexercised EMI options is £3,000,000 (again, calculated at the relevant dates of grant).
When can an EMI option be exercised?
The EMI code requires that EMI options must be capable of being exercised within 10 years of the date of grant. Furthermore, EMI options may only be exercised within 12 months of an EMI option holder’s death. Save for these restrictions, a company has flexibility as to the rules it wishes to implement on when an EMI option may be exercised. For example, they could be exercised on an exit event (for example a sale of shares or of the business) or at the end of a performance or vesting period.
Tax treatment for the company
A corporation tax deduction may be available when EMI options are exercised. This can be particularly relevant when those EMI options are exercisable only on an exit. The main seller of the shares in any company which has granted EMI options should consider factoring in any potential corporation tax deductions to purchase price agreed with a potential buyer.
Tax treatment for the employee
The EMI option must be:
a) registered with HMRC; and
b) notified to HMRC within 92 days of the grant date, using the ERS Online Service, to benefit from favourable tax treatment.
On the assumption that the EMI option remains a qualifying option (i.e. a disqualifying event has not occurred (for example, the company’s workforce has increased to over the maximum number of employees or the gross assets exceed the limit imposed by the relevant legislation)) the tax treatment is as follows:
On grant of the EMI option
There is no income tax liability on the grant of the EMI option.
On exercise of the EMI option
There is no income tax liability on exercise of the EMI option provided that 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 at grant of the EMI option, an income tax liability arises.
The market value should be agreed with HMRC at (or around) the time that the EMI options are granted.
On disposal of the EMI option
On a sale of any shares which are held as a result of the exercise of EMI options, capital gains tax may be payable on any gain over the market value at grant (i.e. on the difference between the sales proceeds and the market value of the EMI options at grant). This is preferable to the position under an unapproved share option scheme where income tax would likely be payable.
It is also worth noting that entrepreneurs’ relief may also be available provided the relevant conditions are met (with the period for which the EMI option is held (prior to exercise) counting towards the 24-month holding period required for the relief to apply and the requirement to hold at least 5% of the ordinary share capital and voting rights not being applicable).
Disqualifying events of the EMI option
If a disqualifying event occurs, any favourable tax treatment of an EMI option will be affected. That is not to say that the favourable tax treatment will be lost altogether but when the EMI option is exercised (i.e. how long after the disqualifying event takes place) and whether the price payable on exercise of the EMI option is at a discount from market value at the date of grant must be considered.
National insurance contributions
National insurance contributions are usually only due on the exercise of EMI options if income tax is payable (for example, because the exercise price is less than the market value at the date of grant) and the shares are considered to be readily convertible assets (which, for private limited companies, will usually only be if the EMI options are exercised just before an exit event).
Final thoughts
An EMI share scheme provides an excellent form of “reward” that companies can offer to existing and prospective employees which can be both cost saving for the company and tax efficient for employees. If you are considering offering an EMI share scheme or would like to discuss other possible equity incentive schemes for employees, please contact Kelly Whitfield on 0207 611 2303 or Arran Brooker on 0207 611 2387.
This article does not provide legal advice nor should it be relied upon by anyone receiving it for the purpose of making decisions in relation to their business or otherwise. This article sets out some general concepts which may be relevant for business owners and managers to consider bearing in mind the current uncertain financial landscape
Author – Arran Brooker
