Many small and medium company owners would like to reward and incentivise key employees by awarding them shares in the company. But they are often put off by the complexity and cost, by tax issues, and by anxieties over giving up control of the company.
Enterprise Management Incentives – or EMI share options – may well be the answer.
This article describes what EMI schemes are and how EMI share options can be best utilised.
Table Of Contents
- What are EMI scheme and EMI share options?
- Why have EMI schemes?
- Looking for EMI Scheme advice?
- Should employees have EMI share options or shares?
- How are EMI share options taxed?
- So how might EMI options make a difference?
- Who can receive EMI options?
- How does EMI work in practice?
- Conclusion
- How Goringe Accountants Can Help With Your EMI Scheme
Option exercise may occur, for example, after a specified period of employment, or upon the achievement of performance targets, or upon the sale of the company.
Why have EMI schemes?
Employee share ownership helps to align the interests of a company’s owners with that of employees. All are looking to increase shareholder value through growing the business, in the hope that they will eventually benefit through sale of their shares or through receiving dividends.
Looking for EMI Scheme advice?
Having share options can provide more of an incentive than having shares, if the share options are only exercisable upon achievement of targets. And many companies prefer employees not to have shares from the outset, because of complications if employees leave. So, more often than not, the preferred solution is share options rather than upfront shares.
EMI Scheme Example 1
John pays no tax when the option is granted, but on exercise he is treated as having received taxable earnings of £90,000 (£100,000 share value less £10,000 option exercise price). He pays income tax at his marginal income tax rate, tax of up to £40,500, even though at this stage he has received no cash.
On sale of the shares, John pays capital gains tax on the £50,000 growth in value since he acquired the shares. Ignoring any reliefs he may have available, tax is charged at a rate of 28%, tax of £14,000.
So although John has been very fortunate in being able to acquire shares for £10,000 and sell for £150,000, he has had to pay tax of up to £54,500, most of which is payable well before he has received any money (and which might have been lost altogether had the shares collapsed in value).
So how might EMI options make a difference?
EMI Scheme Example 2
Jane pays no tax when the option is granted, and nor does she pay any tax when the option is exercised.
On sale of the shares, Jane pays capital gains tax on the gain of £140,000 (£150,000 sale proceeds less £10,000 option exercise price). Ignoring any reliefs she may have available, tax is charged at a rate of 10%, tax of £14,000.
So Jane has saved tax of approximately £40,000 as compared to John, and paid no tax at all until after receiving her share sale proceeds. EMI tax treatment has been hugely advantageous for Jane.
Who can receive EMI options?
Employees (including directors) qualify if they are engaged to work at least 25 hours per week for their company or group or, if less, for at least 75% of their working time. So a part time employee can qualify by working say two days a week for the company, provided that work elsewhere does not amount to more than 25% of the whole.
Employees do not qualify if they already own over 30% of the company.
A qualifying company or group must be independent, i.e. not controlled by another company. At the date of option grant, its gross assets must not exceed £30 million and it must have fewer than 250 employees or full time equivalents.
The company or group must carry on a trade and must not, to a substantial extent, carry on excluded activities. These are non-trading activities such as property investment, and a number of trades, including:
- property dealing and development
- banking and insurance
- legal and accountancy
- farming and forestry
- leasing and licensing (with exceptions for licensing of self-generated intellectual property)
- hotels and care homes
How does EMI work in practice?
- which employees should be granted options, and over how many shares
- when should options be exercisable, for example should exercise be based on performance targets or occur only when the company is sold
- what type of shares should be subject to options, for example should they be ordinary shares or a special share class designed for options, perhaps non-voting shares
- how much will employees have to pay to exercise options and acquire their shares
- what happens if an option holder leaves the company
Once these issues are decided, formal EMI option agreements should be prepared recording all the relevant terms. Once signed by company and employee, the options are formally granted.
Option grant must be notified to HM Revenue & Customs within 92 days. Also, it is normal practice to agree the market value of shares with HMRC in advance of the options being granted, as this will provide certainty as to the tax treatment of option exercise.
Conclusion
HMRC statistics show approximately 3,000 companies a year grant EMI options to employees. They are a proven incentive for employees, and companies that do not offer options may be at a competitive disadvantage in recruitment. If your company has yet to implement an option plan, maybe now is the time to consider it.
How Goringe Accountants Can Help With Your EMI Scheme
- Determine whether your company qualifies to grant EMI options
- Design your EMI scheme, including such matters as when EMI options can be exercised, and whether EMI options should be over a separate share class
- Prepare guidance notes for employee participants and, if required, attend employee briefing meetings
- Agree an EMI option scheme share valuation with HM Revenue & Customs
- Review your company’s Articles of Association and, if necessary, make revisions to accommodate employee shareholders
- Prepare all EMI option scheme rules and option agreements
- Prepare board minutes and any necessary shareholder resolutions to allow EMI options to be granted
- Make any necessary filings at Companies House
- Report the EMI option grant to HM Revenue & Customs
- Assist you in preparing and filing annual EMI option scheme returns
- When the time comes, advise on procedures for EMI option exercise and accounting for tax
Resources
- Enterprise Management Incentives (EMI) end of year return template and guidance notes on the GOV.UK website to tell HM Revenue and Customs of registered Enterprise Management Incentives (EMI) options. *per 3rd March 2015
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