Many growth companies want to reward and help retain valuable employees by giving them an option to acquire shares in their companies, and often ask “what’s the most tax efficient way of doing this?” The answer: implement an EMI scheme.
What is it?
EMI (or “Enterprise Management Incentives”) is a tax-advantaged share option scheme specifically designed for smaller companies.
Why do I want it?
A well designed EMI scheme can provide you with a simple way of issuing share options to key employees. At this point, you’ve probably decided why you want to create an option to issue shares – whether it’s a thank you, to motivate and help retain staff or to create a culture of fairness. Using an EMI scheme to do so will benefit your company as:
- employees are given an option to acquire a stake in the business without immediately diluting the holdings of existing shareholders;
- the administrative and tax costs to set up and maintain an EMI scheme are usually low; and
- it’s tax efficient:
- your employee won’t be subject to income tax on grant: options can be exercised in circumstances chosen by you;
- you retain the ability to achieve a corporation tax deduction: you will still be entitled to a tax deduction broadly equivalent to the value of shares awarded when the options are exercised; and
- There is no tax charge on the exercise of an EMI option (provided it was granted at market value). If your company’s share price has increased in value between the time of grant and exercise – any uplift will not be charged to income tax. (However, there will generally be a capital gains tax change when your employee disposes of the shares.)
How do I implement it?
- Agree with HMRC the underlying present market value of the shares in the company. This isn’t compulsory but it can avoid a lot of time and effort later down the line with valuation issues.
- Decide the price that your employees will pay to exercise of the option. Specifically, the issue is whether the price should be set at the present market value, or whether you want to set it at a premium or a discount. The price you set will determine whether employees are liable to an income tax charge when they exercise the option. So, if you set the price at:
- The present market value – the option will begin to acquire value as soon as the underlying value of the company grows. There will be no income tax to pay when the option is exercised, regardless of the value of the shares of the company at that time.
- A premium – the option will only begin to acquire value after a certain threshold of growth in the underlying value of the company has been achieved. There will be no income tax to pay on exercise.
- A discount – income tax (and possibly national insurance contributions) will be charged on the difference between the present market value of the shares and the exercise price.
When can it be exercised?
A concern for many companies is ensuring that their employees will participate in any gain achieved by a future successful disposal, listing of shares or sale of the company. However, equally, they may want to ensure that their employees won’t become shareholders in the company unless or until this “exit event” occurs. Luckily, EMI shares are flexible and it is possible to structure individual EMI options, or all options granted under an EMI scheme, such that they carry a vesting condition that stipulates exercise shall only take place if there is an exit event. This is also popular with venture capital investors.
If you want employees to have the opportunity to become shareholders after a certain vesting period (often 3 years), or when certain personal performance targets have been achieved, this can also be expressed in the vesting conditions of each individual EMI option.
How do I ‘qualify’?
The following criteria must be met to take advantage of an EMI Scheme:
- the purpose is to attract or retain employees;
- your company (that is issuing the options over its shares) must be independent, i.e. not controlled by another company or individual;
- the gross assets of your company or group must not exceed £30m;
- the aggregate value of the shares under option must not exceed £3m; your company or group must not have more than the equivalent of 250 full time employees;
- your company must conduct a “qualifying trade”, carried on wholly or mainly in the UK;
- directors and employees must:
- be an employee of the company or of a qualifying subsidiary;
- work at least 25 hours per week or 75% of their working week for the company;
- have no ‘material interest’ in the company, which includes holding 30% or more of the share capital of the company; and
- hold unexercised EMI options over shares with a total value of more than £250,000;
- the Shares must be ordinary, fully paid up and not redeemable;
- the option must be capable of exercise within 10 years;
- conditions of exercise must be clearly stated in writing; and
- the option cannot be assignable.
If you would like to set up an EMI scheme, be sure to contact a lawyer familiar with the applicable regulations.