Share options are a form of financial instruments that provides the right to buy or sell a specific number of shares at a predetermined price on, based on the holder meeting certain criteria, and/or before a set future date.
Enterprise Management Incentives (EMIs) are discretionary share option schemes specifically designed to incentivise and retain employees, thanks to their favourable tax treatment. Mainly utilised by smaller companies, EMIs have become an essential tool for attracting and maintaining key employees. Each year, thousands of UK startups leverage share option schemes to build and grow their businesses.
How EMIs work
EMIs grant employees the right to acquire shares at a predetermined price (the Exercise Price) within a set timeframe, usually up to ten years. A valuation is undertaken by the company's tax advisers and an exercise price is then set at the market value of the shares at the time the option is granted. When employees eventually buy the shares at or above the market value, the intention is that they avoid any income tax and national insurance contributions. This is why it is not ideal for a discount to be given, as tax implications may arise.
In an ordinary disposal of shares, Employees may face capital gains tax (CGT) when selling their shares. However, as is discussed below, , EMI options can provide CGT relief under certain conditions, benefiting employees significantly.
Share requirements
EMI options can be satisfied by newly issued shares or by transferring existing shares from a shareholder, including an employee benefit trust.. Companies can establish a separate class of shares for EMI options, potentially with different rights, meaning employee ordinary shares could have less or no rights relating to voting and participating in dividends, compared to the other classes of shares in issue.
Qualifying employees and options
In order to be eligible to be granted an EMI option, an employee must work for the company or group for at least 25 hours per week, or if less, for 75% of their working time. It should also be noted, that employees and their associates (business partners or relatives) must not have a material interest in the company whose shares are used for the scheme.
The options must be formalised in a written agreement setting out the grant date, number of shares, exercise price, and conditions for exercising the options. Options must be exercised within ten years. Where the holder of the option dies, the option may only be exercised within 12 months of the death.
Other than those outlined above, there are no other material restrictions on the exercise provisions that can apply to EMI options, and this flexibility means they are often used for exit-only arrangements (i.e. where an option can only be exercised on a share sale, for example).
Eligibility and qualifying companies
EMI eligibility must be determined with the assistance of specialist tax advisers. These advisers will ensure your business meets the following essential criteria:
- Company size – the company must have assets of £30 million or less, and fewer than 250 full-time employees, at the time the options are granted. Full-time employees are those working 35 hours or more per week. Part-time employees will count as a fraction of full-timers, based on the proportion of 35 hours their weekly working hours represent. All employees, whether based in the UK or overseas, will count, and non-executive directors will also count as employees. Employees on specific types of leave (e.g. maternity and paternity) will not count.
- Independence – the company must be independent, meaning it is not a 51% subsidiary of another company, and is not controlled by another company or person. The independence requirement is still met, however, if the company is subject to an employee-ownership trust. There must not be any arrangements in existence that would ultimately cause the company to fall foul of the independence requirement.
- Subsidiaries – any subsidiary of the company must be a qualifying subsidiary at the time of the grant, with the EMI company holding at least 51% of the ordinary share capital (directly or indirectly), and the subsidiary must not be controlled by another entity. As above, there must not be any arrangements at the time of grant, under which these conditions would cease to be met.
- Trading – the company must be a trading company or the parent of a trading group, operating with the intent of making profits, and not being predominantly engaged in certain excluded activities. Excluded activities include dealing in land, commodities, shares, securities or other financial documents, and banking, insurance or money-lending activities, property development, leasing and farming. The trading requirement must continue to be met, so it is not enough that this is satisfied at the time of the grant. If the relevant company ceases to be a trading company, this will be a disqualifying event.
- UK presence – the company, or its trading subsidiary, must have a permanent establishment in the UK.
EMI eligibility must be determined with the assistance of specialist tax advisers.
Seeking advance HMRC clearance
Companies should always seek tax clearance in advance from HMRC. This process involves submitting detailed company information to HMRC's Small Company Enterprise Centre, following specific guidance to ensure compliance. This includes that there must be genuine uncertainty, so a submission should not be made where the matter is straightforward.
EMI tax treatment
As mentioned above, EMI options offer significant tax benefits. Companies employing the option holders may be entitled to corporation tax relief in the accounting year in which the options are exercised.
If the option is and remains a qualifying option, i.e. no disqualifying event has taken place before the exercise, then the employee should be able to benefit from the following tax treatment:
- On grant – no income tax liability.
- On exercise – no income tax liability if the exercise price was at least equal to the market value of the shares at grant. If the exercise price was less than that, then income tax is due on the difference between the exercise price and the market value at grant.
- On disposal – CGT may be payable on any gain over the market value at grant. However, shares acquired on the exercise of EMI options qualify for Entrepreneurs Relief, provided certain conditions are met. Entrepreneurs Relief allows individuals who qualify to pay 10% tax on any capital gain as opposed to the standard rate of CGT which is currently 20%.
EMI share options are great for companies to provide to their employees as part of their remuneration packages. Whilst the schemes require specialist tax advice, understanding the detailed requirements and benefits of EMIs can help businesses implement these schemes and maximise their potential.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.