Research shows that companies that offer their employees shares or share options are more likely to outperform those companies that do not.

It therefore comes as no surprise that over 14,000 companies across the UK use an EMI share option scheme (Enterprise Management Incentive) as means of attracting, retaining and motivating employees.

What is an EMI Share Option Scheme?

‍An EMI is a type of share option granted to employees that enjoys favourable tax treatment. They are predominantly used by SME businesses in the UK. EMI share option schemes enable companies to share their success with (selected or all) employees in both a commercially flexible and tax-efficient way. They are also a good way of negotiating an overall package for employees rather than a discussion purely on salary.

EMI options take the form of a written agreement between the option holder (i.e. the employee) and the grantor (i.e. the employer company) which states the main terms of the EMI option, including how and when it may be exercised.

The rules in relation to an EMI share option scheme can be quite fluid in terms of exercise conditions and price. The timing of the exercise of an option can be structured according to a preferred approach. For example, companies will often only allow an exercise of an option on an exit (i.e. when the business is sold). This prevents having numerous minority shareholders. Options can also be structured so that they lapse when an option holder leaves the business. This bypasses issues with having to buy shares back from the employee when, and if, they leave.

As a business owner implementing an EMI share option scheme, you can determine the extent of employee ownership. This includes the extent to which employees participate in underlying business value and whether they are to have voting and/or dividend rights.

What are the tax and non-tax benefits for employers?

‍An employer can claim Corporation Tax relief when an employee sells the shares and when they exercise the shares (if those shares were granted at a discount).

If an employer grants an employee options at the actual market value, the Income Tax charge when they exercise the options is zero, so there is no Corporation Tax deduction in this scenario.

If an employer grants an employee options at a discount, the Income Tax they pay is on the difference between the actual market value and the discount. The employer can claim Corporation Tax relief equal to the Income Tax amount the employee paid.

If an employee sells the shares, they will pay Capital Gains Tax. The employer can claim a further Corporation Tax deduction equal to the amount of Capital Gains Tax the employee paid.

In addition to generous tax benefits, other benefits of EMI share option schemes include:

·        retaining and motivating staff – a key benefit is allowing businesses to attract and retain the most skilled team possible by giving key employees a sense of ownership in their employing company, its growth and ultimately its financial success;

·        flexibility on who gets share options  – not all employees have to be part of the scheme as the rules allow the directors plenty of discretion on who participates and on what terms;

·        flexibility on structure that matches your commercial objectives – the decision on who receives EMI options, how many shares are awarded, the price payable and when the options are exercised are all left to the discretion of the directors. The scheme could be performance driven, where employees are incentivised to meet specific business or personal goals, and/or it can be time based where employees can build up a shareholding over time; and

·        the scheme can be exit only – this means it is only when the company is about to be sold do the employees exercise their EMI options and become shareholders. The employees then go onto immediately sell their shares along with other shareholders on sale. Our documentation will provide that no employee can hold up the sale.

What are the tax and non-tax benefits for employees?

‍The tax benefits of EMI share options for employees include:

·        no Income Tax or National Insurance Contributions (NIC) is charged when the options are granted;

·        if an employee exercises their options at the pre-agreed market value (AMV) with HMRC, they won’t pay Income Tax or NIC on exercise either; and

·        if an employee has held their options or shares for at least two years before they sell them, the Capital Gains Tax they pay on sale will be reduced from 20% to 10% (entrepreneurs’ relief (“ER”)). There is also no need for a 5% holding under EMI in order to qualify for ER; so even small minority holdings of Growth Shares can potentially qualify for the 10% rate of CGT.

In addition to generous tax benefits, other benefits of EMI share option schemes include a motivated workforce. Participating employees feel more engaged, valued and motivated because they can share in the collective success of the business, and their effort is rewarded in a way that is tax efficient for them and the business.

What is the process to setting up an EMI Share Option Scheme?

‍The process to setting up an EMI share option scheme falls into the following key stages:

1.      Evaluating if the company and (selected) employees meet all of the requirements to qualify for an EMI scheme – see below for a summary of the company and employee criteria. If there is any hesitation regarding whether the company qualifies for issuing EMI options, it is possible to apply to HMRC for advance assurance.

2.      Designing scheme rules and agreements with employees / drafting of legal documents – the legal documents will typically consist of a set of scheme rules, an option agreement for each option holder, an employment-related securities election under section 431 Income Tax (Earning & Pensions) Act 2003 and board minutes approving the scheme. The EMI scheme rules set out the umbrella terms and conditions for the options and the procedure for grant and exercise. The option agreement sets out, between the company and the employee, the specific award, exercise price, exercise conditions, how and in what situations the options may lapse, good leaver and bad leaver provisions and other important details.

3.      Agreeing a valuation with HMRC for the shares over which options would be granted – the company or their adviser should file with HMRC to get an EMI share valuation. The valuation does not necessarily need to be a professional one, but it is recommended as independent valuations can be helpful in the event of a dispute with HMRC and can also help satisfy a buyer undertaking a due diligence exercise in future. The valuation, once agreed, is normally effective for 90 days.

4.      Establishing employee share pool and obtaining corporate authorisations – a corporate framework needs to be implemented in order to grant options. This can involve getting relevant internal approvals from the company’s Board of Directors and shareholders, establishing new Articles of Association (if the current Articles do not permit option-granting), and authorising the employee share pool.

5.      Grant EMI options – the options should be granted to the selected employees within three months as the approved valuation remains valid for 90 days from the date HMRC approves it. The granting of EMI options involves the company entering into a formal deed, communications with employees and signing the relevant option agreements.

6.      Register the EMI share option scheme and the grant of options with HMRC – this must be done within 92 days of the date of grant. Failure to do so causes the option to be treated as an “unapproved option” and as a result, the EMI tax breaks will be lost. Please note that EMI options granted from 6 April 2024 onwards need only be notified to HMRC by 6 July following the tax year of the grant, which is a considerably longer window for carrying out this stage.

7.      Ongoing reporting - there will be ongoing annual HMRC reporting requirements following set up which we can help you with.

EMI eligibility for a company/employer

‍To be eligible, a company must:

·        together with its group company, have gross assets of £30 million or less;

·        be independent (i.e. not controlled by another company);

·        have fewer than 250 full-time equivalent employees;

·        be established permanently in the UK (if not, another qualifying company in its group must be);

·        not operate in ‘excluded activities’ including, banking, farming, property development, legal services and ship building; and

·        use ordinary shares – although such shares do not need to have full rights attached to them (e.g., they may have no voting rights).

EMI criteria for individual employees

‍To be eligible to be granted an EMI option, an employee:

·        must work for the company for at least 25 hours per week, or if less, 75% of their working time;

·        cannot hold more than 30% of the company shares; and

·        cannot be granted options if they (or their “associates”) have a “material interest” in the company whose shares are used for the scheme, or in certain related companies.

Options can only be granted to employees. They cannot be granted to non-executive directors or consultants.

Designing your EMI Share Option Scheme

‍After establishing that your company and selected employees meet the respective EMI eligibility criteria, you can design your scheme. The issues to take into consideration when designing your scheme include (but are not limited to):

·        What should happen to leavers?

·        What are the company’s and existing shareholders’ goals?

·        Should employees share in existing or just future value?

·        How large should the employee option pool be?

·        What is the current valuation of the company?

·        Who should participate and to what extent?

·        How will employees realise value from their shares?

·        When should employees be able to acquire shares?

When designing and implementing your scheme, it is essential that HMRC and other relevant legal obligations are complied with. It can be very costly when employees come to exercise their option if the scheme is non-compliant. Seeking professional advice when implementing an EMI share option scheme is therefore essential.

For further information on EMI share option schemes, and how we can support your business in implementing one, please contact us today on 01293 596900.