Essentially, qualifying companies can set up an Enterprise Management Incentive (“EMI”) scheme whereby options can be granted over shares to qualifying employees worth up to £250k (each employee) without giving rise to an income tax or NIC charge. They also allow the employee to purchase shares in the company for a discounted value. The total value of shares in a company which may be subject to unexercised EMI options at any time is £3 million.
EMI option schemes are intended to help companies retain valued employees and to reward the employees for investing their time and skills in helping the company grow.
The options allow the employee to exercise (i.e. buy the shares) at the market value of the shares when the options were granted – the intention being that when the options are exercised the market value of the shares is higher, therefore the employee has received the shares at a discount. When the shares are eventually sold by the employee they will be liable to Capital Gains Tax (“CGT”) on any gain over the market value at grant and qualify for Entrepreneurs Relief meaning an effective CGT rate of 10%.
While there is no income tax liability on the grant of an EMI option, there may be an income tax liability on exercise. If the exercise price was less than the market value at grant, then income tax is due on the difference between the exercise price and the market value at grant.
Broadly, the National Insurance Contributions (“NICs”) treatment of EMI options follows the income tax treatment in that there will be no NICs if no income tax is due, but there will be such contributions due if income tax is payable and the shares are readily convertible assets. The employer and the employee may enter into arrangements under which the employer NICs liability is transferred to the employee.
Qualifying companies are those which are not subsidiaries of another company, are UK based, have gross assets of no more than £30m, have fewer than 250 employees and must participate in a qualifying trade with a view to realising profits.
Qualifying trades are any that are not investments in land, shares or financial instruments, financial services, leasing assets, licence/royalty fees receipt, legal/accountancy services, property development, farming or forestry. Qualifying employees are those who work full time (defined as at least 25 hours per week or for at least 75% of their paid working time) and do not hold more than 30% of the company’s shares.
There is no advance approval process required from HMRC although there are HMRC notification and reporting requirements (see below).
Setting up a scheme and valuation
In order to set up a scheme, the company’s articles of association will need to be checked (and possibly altered) and option scheme rules drafted in the form of an agreement between the company and the employee/director.
A valuation of the company will also be required to establish the market value of the shares. The valuation is then agreed with HMRC. The main circumstances in which a valuation is required include on 1) grant of the EMI options (the tax market value of the unquoted shares on grant is required in order to calculate the £250,000 limit applicable to EMI options, to complete the HMRC notification form following grant and to determine whether there will be a tax charge on exercise) and 2) exercise of the EMI options (if an income tax charge arises on exercise the market value of the shares on exercise needs to be agreed with HMRC so as to calculate the tax due).
Share valuations vary depending upon the nature of the business and the company’s stage of development. Factors that may be considered include the assets of the company, the historic trading position, dividend yields, comparable price earnings ratios, any recent investment rounds or offers to acquire the company and comparable selling prices of similar companies in the sector.
The option scheme rules and agreement can contain good and bad leaver provisions that avoid an employee leaving and taking shares with them. These provide that on an employee leaving a company there is an automatic transfer of shares held by that employee. Employees will be treated as good leavers (typically on death, disability and sometimes, redundancy) or bad leavers (dismissed for other reasons or resigning). Good leavers typically get “fair value” and bad leavers get par value or the price paid on subscription if higher. The scheme rules also include detail about how and when the options can be exercised and can relate to certain performance targets being met. The options may also lapse and be forfeited if the employee tries to assign them or grant security over the options. As the employer has responsibility for making income tax and national insurance payments through PAYE to HMRC the option scheme agreement should contain appropriate indemnities for tax and national insurance contributions and provisions for recovery of such payments from employees.
The shares under option must be part of the ordinary share capital of the qualifying company, fully paid up and not redeemable, while the options must be capable of being exercised within 10 years.
From a tax perspective, the scheme must be registered with HMRC within 92 days of establishment and there is an identical timeframe for notifying HMRC of any options being granted. There is an annual return (known as an EMI40) that must be filed by 6th July following the end of the tax year. The scheme registration, option notification and EMI40 filing must take place online and failure to notify/file can lead to the scheme being cancelled and the tax advantages being lost.
We can advise on and produce appropriate EMI share option schemes on a fixed fee basis, with prices starting at £2,500 plus VAT which includes all contractual documentation, tax advice, HMRC paperwork and valuation.
Assistance we may provide includes:
- obtaining advance assurance from HMRC;
- providing advice to the company and its employees on the tax implications of an EMI scheme;
- producing the option scheme contractual documentation;
- agreeing a current share valuation with HMRC to determine the exercise price;
- assisting with the online registration of the EMI scheme;
- online notification of the grant of the EMI options; and
- assistance with the first EMI scheme return.
Please get in touch with us for a free initial consultation, following which we will be able to provide you with a competitive quote.