The EMI (Enterprise Management Incentive) was introduced in 2000 to help small and medium sized businesses to retain and reward their employees.
If you are offered the option of shares under an EMI – what do you need to consider before deciding if this is the right option for you?
What is an EMI scheme?
An EMI is an HMRC-approved employee share scheme that is tax advantaged. A company may offer share options to employees up to the value of £250,000 in a 3-year period.
‘Tax advantaged’ means any form of investment that is exempt from taxation or where payment of tax is deferred. In this instance, you won’t have to pay related income tax or national insurance on receipt of the shares. provided the EMI qualifying conditions are met.
However, if you were given the options at a discount to the market value, then you will be required to pay income tax and national insurance on the difference between the two values.
Should you sell the shares at a future date, you may be required to pay capital gains tax.
What are the eligibility requirements for an EMI scheme?
Companies who are eligible to offer an EMI share scheme must meet the following conditions:
- The company must have gross assets of no more than £30 million.
- It must be a ‘for profit’ trading company, and not an investment company.
- It must not be a subsidiary of another company, or controlled by another company, although parent companies may qualify for EMI schemes.
- There must be fewer than 250 employees when the EMI options are made available.
- It must have a permanent establishment in the UK.
Companies who may not offer an EMI share scheme because they work in excluded activities include, but are not limited to,
- property development
- farming, forestry or marketing gardening
- legal services
- ship building
- financial services
- accountancy services
- receiving royalties or licence fees
- coal and steel production
- nursing homes or residential care homes
Conditions an eligible employee must meet include:
- They must be employed by the company who will issue the shares or be an employee of a subsidiary of the company.
- They must work at the company for at least 25 hours per week or at least 75% of their working time.
- They must not already hold more than 30% of the company shares before the EMI option shares are made available to them. This is called a ‘material interest’.
How does an EMI scheme work?
An employee is given the option to receive ordinary shares in the company that employs them. The price of the shares is fixed at that point, and the HMRC are notified.
In accordance with the terms of the share option agreement, the employee takes up the share option and acquires shares for the agreed fixed price.
Usually, this will happen when the employee has already worked for the business for a number of years, when the company is sold to a third party, or should the company be listed on the stock exchange.
There are a number of conditions that must be met:
- The shares offered under an EMI scheme must be drawn from the ordinary share capital of the company and be fully paid up.
- It must also be possible to take up the option within 10 years of the original offer or ‘grant’ being made.
- The rules surrounding the shares themselves, and what can be done with them, must be provided in writing to the employee when they receive the shares.
- It must not be possible to transfer the shares from the employee to a third party.
- The purpose of granting share options must be commercial, i.e. to retain and reward an employee, or in some situations to recruit an employee.
- The total market value of shares offered under an EMI scheme must not exceed £250,000 within a period of 3 years.
The tax situation
When the share options are granted, there is no related income tax or national insurance charged to the employee at that point as long as they exercise their option, that is take up the shares within 10 years.
What happens when you take up the shares (exercise your option)?
Should the share price be more than or equal to the market value of the shares when the option was granted, there will be no income tax to pay.
What this means is that, should the company have increased in value since the granting of the shares (and hence the shares increased in value), then the resulting difference (sometimes called an uplift) is tax-free for the employee. This is the main benefit of an EMI share scheme for an employee.
If the share options were made available at a discounted price, and again there is an increase in price upon sale of the shares, income tax will be charged at the point of exercise.
If the share price at the time of exercise is less than the share price when they were granted by the company, the tax charge will be based on the market value at the time of exercise.
National insurance will generally not be incurred by the exercise of EMI shares.
When an EMI scheme grants shares as part of an exit-based scheme (where an employee cannot buy shares until the company goes through an exit event such as a trade sale), then should the shares be acquired at exercise for less than the market value when they were granted, tax and national insurance will be charged.
What happens if you sell your shares?
Should an employee sell their shares, any resulting profit (the price of the shares at the time of sale less the price of the shares upon exercise) will be subject to capital gains tax.
The employee may use their capital gains tax annual allowance (£11,700 for 2018/19) to offset this amount. Any gains over the annual allowance will then be subject to capital gains tax.
What else should you consider before taking up EMI share options?
Are the shares discounted?
If the shares are offered to you at a discounted price then at the time of exercise, you will become chargeable for income tax.
Can tax advantages be lost?
Should a disqualifying event take place, then income tax may become chargeable.
Any tax benefits may be lost if a disqualifying event takes place. Examples of disqualifying events include, but are not limited to,
- The employee ceases to qualify for the EMI scheme:
They leave employment with the company.
Their working hours reduce to less than 75% of their working time or less than 25 hours per week.
- The company is no longer independent and hands over control to another company.
- The company takes on restricted activities.
- The company changes to trade mostly outside the country.
- The terms of the option are changed.
- The company’s share capital is altered.
- The shares of the company are converted to a different class of share.
- A further grant of shares takes the company over the £250,000 limit in a 3-year period.
- A shareholder departs which results in an EMI option holder having more than a 30% holding of the company share capital.
Unapproved share options
A company may offer unapproved share options to their employees, but these offer no tax benefit. They are subject to income tax and national insurance in the same way that a salary or bonus is subject.
Share Incentive Plan (SIP)
Within a SIP, there are four types of ordinary shares that a company may offer to its employees,
- free shares, up to the value of £3,600, with no extra income tax or national insurance
- partnership shares, up to the value of £1,800 or 10% of income for the tax year (whichever is lower)
- matching shares, provided by the company to match taken up partnership shares at a ratio of up to 2 matching shares per partnership share
- dividend shares, purchased by an employee’s dividend income, with no income tax charged on paid out dividends
These are actual shares, rather than share options.
Save as you earn (SAYE)
Ordinary shares with voting rights are made available to employees after 3 or 5 years employment with a company, at a discount. The employees pay between £5 and £500 on a monthly basis for a period of 3 to 5 years towards the purchase of the shares at the end of that time.
The grant and exercise of the SAYE share options incur no income tax.
Company Share Option Plan (CSOP)
The maximum value of shares that an employee can acquire under this scheme is £30,000, with an option period of 3 to 10 years.
Income tax and national insurance are not chargeable upon grant or exercise of the share options.
Why legal advice is important
Although there are tax benefits in taking up share options in an EMI scheme, the process and considerations are far from straightforward.
Specialist legal advice can guide you through not only the process but also make an informed decision on whether an EMI scheme is the best option for your financial situation now and in the future.