Enterprise Management Incentive option schemes
Tax efficient Option schemes for staff retention
We have set up several EMI schemes for clients and we are able to offer realistic economic rates that suit growing entrepreneurial companies. The preparation of EMI schemes is one of our core activities and our approach is highly efficient. Typically we can deal with the documentation by phone, post and email but if you would like a 'full service' basis, which would include face to face meetings (which can encompass presentations to staff for example) we are very happy to undertake this too. We will take care of your company valuation agreement with HMRC too. To discuss your requirements please call or email Jerry Davison - see contact details
The key information we will need includes -
- the number of employees to be included in your scheme
- the number of share options to be granted to each individual
- the period over which the options will vest and the structure for the vesting (e.g. vested all upfront, or over a 3 year period)
- when an employee can exercise options and buy actual shares (e.g. anytime after vesting, or only on a sale of the company)
- the price of the options, and the basis for that price (valuation)
- your Articles and any shareholders' agreements
There are several other issues to discuss but they tend to be more technical and can be easily addressed during the process.
Share options and EMI
EMI is a form of share option
scheme that provides significant tax advantages to employees. Share options are
very useful for companies who wish to incentivise and retain key employees. The
business can grant options over equity shares to individuals, based on a
specific structure for how and when they can purchase the underlying shares. It
is quite a popular model in start up and early stage companies, which generally
want good staff but who don’t necessarily have the cash to pay full market
level salaries.
Share options provide the
potential for a medium to long term capital gain, possibly substantial, at the
expense of foregoing shorter term salary payments. More established firms also
use share options as well, as part of their overall package for key employees.
Companies can structure share
options in all sorts of ways, for example so that they are only exercised on
“exit” i.e. when the business is sold.
In most cases, employees both
buy and then sell their shares on the day of an exit, so that they end up with
the net gain.
What is the “EMI”?
The
Enterprise Management Incentives Scheme (the “EMI”) was introduced in the
Finance Act 2000. It aims to assist small high-risk trading companies in
attracting and retaining key employees and to reward those employees for taking
the risk to work for such companies.
The
EMI allows a qualifying company to grant options over shares with a value of up
to £120,000 per employee (up to a maximum of £3million) on very flexible terms.
The EMI offers favourable tax treatment making it attractive to both companies
and employees.
What companies qualify?
·
The gross assets of the company
(or the group of companies if a parent company) must not exceed £30million.
Gross assets broadly comprise all assets shown in the balance sheet when drawn
up in accordance with standard accounting practice.
·
The company must have fewer than
250 employees.
·
The company must be independent
and not under the control of any other company. Control for these purposes is
defined as the ability of a person to secure that a company acts according to
his wishes, whether through share ownership or provisions in the Articles of
Association of that company. Shares in a subsidiary cannot be used in an EMI
option.
·
Companies may be quoted or
unquoted.
·
There is no requirement that the
company be resident or incorporated in the UK but the company’s trading
activities must be carried out wholly or mainly in the UK. Group companies can
offer the EMI to employees of both the parent and the subsidiary companies,
provided that all of the subsidiaries in the group are qualifying subsidiaries.
Broadly, this means that the parent (or another subsidiary) must own at least
75 per cent of the share capital and that no other person or entity should
control (as defined above) that subsidiary.
·
Certain trades are excluded from
the EMI. Excluded trades include leasing, financial activities and property
development and from the date of Royal Assent of the Finance Bill 2008,
shipbuilding, steel and coal producing companies. For a group, the activities
of all group companies will be treated as a single business. Any excluded trade
which is merely incidental to the trade carried on by the company or the group
of companies will be disregarded.
What employees qualify?
To
qualify, employees must:
·
work for the company (or, if
relevant, any group company) for at least 25 hours a week or for at least 75 per
cent of their working time (which includes time spent in self-employed work);
·
not have a “material interest” in
the company (or, if relevant, any group company) (defined very widely by
reference to a holding of more than 30 per cent of that company).
Are there any restrictions on the grant of options?
Each
employee can only hold a maximum of unexercised options worth £120,000 in any 3
year period under the EMI. Any further options granted to an employee over and
above this sum would not qualify for EMI relief. The 3 year period will begin
to run from the date of the grant of the last option that took the total held to
£120,000.
Companies
are free to set their own option period, but options must only be capable of
exercise within 10 years of being granted and be exercised within that period.
After 10 years have elapsed the tax benefits of EMI no longer apply to the exercise
of any outstanding options.
Companies
are also free to set the option price which may be more or less than the market
value of the shares on the date the option is granted. The shares over which
options are granted must be fully paid up ordinary shares. It is not possible
to grant an EMI option over redeemable or convertible shares.
How is the EMI operated?
A
separate agreement will be required in respect of each option granted to an
employee. This enables the company to tailor each grant of an option to the
particular employee.
Does HMRC supervise the operation of the EMI?
There
is no need for prior approval of the EMI from HMRC- the company must simply
notify HMRC within 92 days once an option has been granted. A company can seek
advance informal assurance from HMRC that it is a qualifying company.
HMRC
has a period of 12 months from the expiry of the 92 day notification period in
which to check whether the grant is within the EMI rules. The company will have
a right of appeal against any HMRC decision that this is not the case.
HMRC
has a power to require the company to provide it with information to enable it
to carry out an investigation into the grant of options. Any valuation of
shares in connection with the EMI will need to be agreed with the Shares
Valuation Division of HMRC. It is intended that this process will be
streamlined as much as possible. Companies who grant EMI options will need to
make a return to HMRC within three months of the end of each tax year.
What other requirements are there?
The
employee must be prohibited under the terms of the grant of the option from
transferring any of his rights under the option. If the option is capable of
being exercised after the employee’s death, it must not be capable of being
exercised more than one year after his death. There are provisions in the
legislation for dealing with the EMI options if the company which granted them
is the target of a successful take-over. In certain circumstances the holder of
the option can agree with the acquiring company to surrender his option in
return for a replacement option to acquire shares in the acquiring company.
What are the tax advantages of EMI options?
No
income tax or national insurance contributions (NICs) are payable on the grant
of an EMI option. Where the option price is equal or greater than the market
value of shares on the date that the option is granted, then no income tax or
NICs (including employer’s NICs, currently at 12.8 per cent) are payable on the
exercise of the option.
Companies
may set the option price at a discount (or even at nil). However, where this is
the case then, on exercise of the option, income tax will be payable on the
discount (the excess of the market price of the shares on the date the option
is granted over the exercise price paid by the employee). Where the shares can
be readily converted into cash when the option is exercised, any such income
tax must be accounted for under PAYE and NICs (employer and employee) will also
be payable on the taxable amounts.
When
shares obtained on exercise are eventually sold the employee will be liable for
capital gains tax (CGT), currently 18%. The annual CGT exemption will be
available. The costs of setting up and administering the EMI will be deductible
expenses for the company when calculating its profits for the purposes of
corporation tax.
Can the tax advantages be lost?
If
at any time prior to the exercise of an option a “disqualifying event” occurs
then, on a subsequent exercise of the option, an employee will be subject to
income tax in the usual way as on the exercise of an unapproved share option.
However, the gain will be calculated by reference to the market value of the
shares on the date of the disqualifying event. Examples of disqualifying events
include:
·
the employee ceasing to be a
qualifying employee
·
the company ceasing to be a
qualifying company