If you have key employees whose know-how is essential for the running of your business or if you are seeking to attract the best and brightest external hires to your company, providing them with tax favoured options to acquire shares in your business can be a big incentive.
This article gives a brief overview of why implementing an Enterprise Management Incentive (EMI) option scheme can be of benefit to a company and details common areas where issues can arise.
An EMI option scheme is a type of tax favoured scheme a company can use to motivate and incentivise its employees by granting them an option to acquire shares in the company.
Employers like EMI options as they can be an effective tool to recruit and, more crucially, to retain employees by offering them a stake in the business that they are working to build. Employees like them because the options give them a stake in the company in which they are working, but they also receive favourable tax treatment.
This has made EMI option schemes the preferred share option plan for many companies.
The key advantage of an EMI option is the favourable tax treatment afforded to the optionholder. On the grant of the EMI option there is no income tax liability for the optionholder, nor is there on exercise, so long as the exercise price of the option is at least equal to the market value of the shares on grant. Shares acquired on the exercise of EMI options also qualify for entrepreneurs' relief, provided certain conditions are met. Capital gains tax may be payable by the optionholder on disposal of the shares but only on the difference between the sale proceeds and the market value at the date of grant.
Companies can impose any reasonable conditions on the exercise of the option, but they are usually either exercisable upon a sale of the company or after a set time and when certain performance conditions have been met (for example, when the business has reached a particular size).
It is a common pitfall for schemes to allow employees to exercise their options immediately upon grant or very shortly afterwards (i.e. without the need for any conditions to be satisfied). If this happens, HM Revenue & Customs might take a dim view and see that the options were just granted as a way of tax avoidance rather than as a way to retain and motivate employees within a company.
There are, of course, limitations to EMI option schemes that a company should be aware of before implementing them. They are, as an employment incentive scheme, linked to a person’s employment, and therefore the option holder needs to work for at least 25 hours per week in the business or, if less, 75% of their working time. This ensures that it is only genuine employees of the business who benefit from these tax favoured option arrangements.
Additionally, there is a £250,000 limit on the value of the options that can be granted to each employee under an EMI option scheme to prevent their tax favoured status being taken advantage of by founders and business owners. EMI options can still be granted for more than the £250,000 value level, however, to do so means they will lose their tax favoured treatment.
It is also important to note that previously granted EMI option schemes can be disqualified if there is a change of control of the company, even if this is the result of an internal reorganisation where a new holding company is placed on top of the company that originally granted the option. If the option is not exercised within a brief time period, the maximum being 90 days, and under the conditions specified in the option, then the option will lapse.
In addition, if the business grows too large, it may no longer qualify for the ability to grant EMI options. To qualify, the company must be an independent trading company with fewer than the equivalent of 250 full time employees and gross assets of no more than £30 million.
Despite the potential pitfalls, as long as care is taken when the options are granted and over the lifespan of the option, they can be a boon to a business and provide a real strategic advantage by maintaining key employees within the company.
What does this mean for you or your business?
Although EMI option schemes are not for everyone, for those that qualify they can produce a real tangible benefit when it comes to employee retention, the advantage of which can, over time, outweigh the cost of their implementation.
What do you need to be doing now?
If you are considering putting in place an EMI option scheme, please do get in touch with a member of our Corporate team.