An Enterprise Management Incentive [EMI] scheme is an HMRC approved employee share scheme. It allows business owners to grant their employees an option to own shares. It is available to most trading companies and is particularly well suited to small and medium sized companies. The scheme’s basic criteria are relatively simple to understand. Overall the scheme is very popular due to its flexibility and the potential to agree values with HM Revenue and Customs [HMRC].
It is a flexible and tax efficient way for an employer to:
The selected employees are offered an EMI option to buy shares in the employing company at a future point. They agree to buy the shares (‘exercising the option’) and the company agrees with HMRC the price they will pay. The most usual idea is that by the time the options are exercised, the share value will have risen, so the employee is effectively buying the shares in the future but at today’s agreed price.
It is worth noting that employees are not obliged to exercise the options, so if the value of the shares has not increased, the employee would be unlikely to exercise the options.
An EMI scheme benefits from an advantageous tax treatment on any increase in the share value between the date of grant and the date of exercise of the options. Providing full value is paid for the shares there is no income tax or National Insurance on any benefit received by the employee.
When the shares are sold, typically only Capital Gains Tax will be due on any value increase. This is the difference in the amount of the sale price and the amount originally paid. This tax is normally payable at 20%. However, if the shares are sold two years or more after the grant of the option and the shareholder has been a qualifying employee for at least the required two year period prior to the sale, the tax payable can reduce to 10% by way of Business Asset Disposal Relief [BADR].
All EMI schemes have a 10 year limit. If the options are not exercised, they will need to be refreshed or they will lapse.
EMI also benefits the business. This is because you can provide your key employees with a financial reward directly linked to the success of your business. This is taxed at a lower rate than a cash bonus or unapproved scheme. You can encourage commitment from your key employees as they can only exercise their options if they remain with the company all the way to an exit. Early leavers usually get nothing.
Adam is granted options over shares currently worth £5,000, a value agreed with HMRC by his employer. He agrees to pay £5,000 should he exercise his option to buy.
Increase in value
Over the option period, the value of the shares rises to £55,000.
Tax on shares sold
When the shares are eventually sold, Adam makes a net gain of £50,000. Under an EMI scheme he could pay £5,000 CGT. Without the EMI scheme Adam might have to suffer perhaps 40% tax and 3.25% National Insurance – over £21,000 which would be deducted under the PAYE system.
Under EMI, Adam would only be charged CGT when he sells the shares acquired under EMI. Without an EMI scheme he would be charged PAYE on any bonus or when he acquired the shares.
EMI is about securing commitment. It is therefore usual to make it a condition that any unexercised options will end if an employee leaves. There is flexibility which allows the individuals to keep the options if they leave for good reasons. You also have the flexibility to allow the options to be exercised in stages, say after an agreed time period had passed or on the achievement of certain performance milestones.
Once the share options have been exercised, the employee becomes a shareholder of the company with the normal rights attaching to the shares governed by the Articles. These may include leaver provisions in respect of shares. In order to prevent an uncontrolled expansion of the share register it is common to write options which allow holders to exercise only in the event of a third party sale.
If you need help with the set-up process of an EMI scheme, please get in touch with David Ford or your usual Crowe Contact.