An Enterprise Management Incentive, or EMI, is a government‑backed, tax-advantageous employee share scheme.
This scheme is available to most trading companies looking to share their successes and incentivising their team as the company grows.
An EMI scheme offers significant tax incentives for employers and employees, provided certain qualification criteria are met. Businesses are also able to set specific conditions for recipients, such as performance or length-of-service milestones.
These schemes can offer flexibility, in terms of both the conditionality and the time frames that can be set as part of their terms.
There are three stages to share ownership:
- Options over shares – this gives qualifying employees a right to acquire shares at a pre-determined price at some future point in time and on certain conditions. At this time, they do not become actual shareholders.
- Exercise of options over shares – with all necessary pre-conditions met, the option over shares is exercised, the participating employee pays the option price for the shares and becomes a shareholder of the company.
- The employee sells the shares acquired.
The Option Price
Preparation and submission of VAL231 Form agreeing on the market value of the shares with HMRC.
The price paid by each EMI option shareholder for their shares when they can exercise their option will be the number of share options they hold multiplied by the approved option price.
What is a “Qualifying Employee”?
To be a qualifying employee, you must either:
- Work for the company for a minimum of 25 hours per week, or;
- Work at least 75% of your total working time for the company. So, for example, if you work 20 hours per week for the New Company and 5 hours per week in another part-time job, then you will qualify because you are spending 80% of your working time at the new company, and;
- You must not hold more than 30% of the total shares in the Company.
When can an option be exercised?
There are two main structures to be considered when deciding on an exercise date for the options:
- Time-based – this can be on an exact date or a set number of years after the grant date, for example, on the 3rd anniversary. However, it must be within ten years of an option being granted (to meet HMRC regulations).
- Exit only scheme – employees are restricted to only exercising their options when the company is sold.
The EMI scheme is quite flexible and so both of the above can be chosen on an ‘earliest of…’ basis.
There can also be performance-related criteria set as a pre-condition of exercising an option.
Additionally, it is possible to include criteria where options can be exercised when an employee becomes a “good leaver”. A “good leaver” will generally be someone who leaves the company for health reasons, retirement or, in some cases, redundancy.
What happens if an employee leaves before options are exercised?
In normal circumstances, the options will simply lapse and the departing employee will lose all rights to the shares. At the company’s discretion the forfeited option may be offered to another employee, but at a valuation of the share at that time.
If the employee is a good leaver and these criteria are chosen to be included, the option may be exercised. There may be a shareholder’s agreement, if not already covered within the EMI Option Agreement, that states that the shares acquired can be bought back by either the company or other shareholders on an agreed basis of value.
If options are exercised, who might buy the shares?
This depends on the exit and timing of the exercise of the option:
If immediately before a sale the options will be exercised and the shares will be immediately sold.
If, for reasons of being a good leaver, there will be a defined path by which options are exercised and the shares acquired to be sold.
In any other circumstance, there will be procedures in place to be able to offer shares back to the company, or other shareholders to be acquired at market value. Shares will not normally be allowed to be retained by anyone who does not remain as an employee of the Company.
Tax issues to employees for EMI Shares
If the share options being granted are at or above the market value agreed with HMRC there is no tax charge on being granted the option. There is no tax charge on the option being exercised, even if the market value exceeds the option price.
If the option price is set at a value below the value agreed with HMRC, a taxable benefit will arise on the employee when the option is granted.
There is a potential tax charge when the EMI shares are sold to the extent that the net proceeds after disposal costs exceeds the option price. This is treated as a capital gain and therefore may be subject to tax at 20%, or even 10% if the time since the options were granted to final disposal of the shares exceeds 2 years.
Based on current rates (as of September 2021), the first £12,300 of gains are exempt for each person in a single tax year.
Tax Issues to Employers
The Company will qualify for a deduction from its profits used to calculate corporation tax based on the difference of the market value of share options exercised and the option price in each financial year that these are exercised.
There are various additional qualifying issues associated with an EMI scheme, all of which are assumed to have been met based on the preliminary work undertaken:
- Your gross assets must not exceed £30m at the time of EMI options being granted. If part of a group, all assets of the group must be included;
- You must have fewer than 250 full-time employees;
- The market value of an option (including all other share options) must not exceed £250,000 per employee at the date of the grant;
- Your business must have a permanent establishment in the UK;
- If your company has any subsidiary companies, they must also qualify for EMI;
- Your company must be independent. More than 50% of the ordinary share capital must not be owned or controlled by another company.
There are several remaining points be discussed and agreed upon when entering into this scheme, including:
- Number of and type of shares to be issued under the EMI scheme.
- The criteria on which options can be exercised.
- Rights of the shares offered in the scheme.
Most importantly, the EMI scheme should be designed to maximise the benefit to the company and employees and must be implemented efficiently to improve employee performance.
- Management accounts – worth your time and resources? - December 10, 2021
- How can an Enterprise Management Incentive scheme benefit my business? - August 16, 2021