Now more than ever, there is a profound need for companies to invest in both attracting and retaining key employees. Moorcrofts corporate partner and CFO Teri Hunter advises that this is critical to the long-term health and success of businesses.
An EMI scheme can be an excellent way to achieve these goals, by rewarding employee’s efforts, and encouraging them to work hard to build value in the business. The long-term nature of the scheme, and potential for financial gain encourages employee retention.
What is an EMI scheme?
An Enterprise Management Incentive (EMI) scheme is a tax-efficient and HMRC approved scheme which allows employers to grant share options to their employees. Employees are offered the opportunity to purchase shares in the company at a price fixed from the start. This fixed option price will usually be agreed in advance with HMRC, following a share valuation prepared by the company’s accountants.
While there is no limit on the number of employees that are permitted to hold EMI options, companies are subject to a cap of £3 million on the total value of shares in the company that are subject to unexercised EMI options at any time. In addition, each individual EMI option holder has a maximum entitlement of £250,000 worth of shares (as valued at the date of the grant option).
Who qualifies under the EMI legislation?
Under EMI legislation, only certain companies and employees will qualify to both offer and participate in an EMI scheme. There are a number of factors to consider, including, but not limited to:
- The company must have gross assets of £30m or less at the time of grant of share options;
- The company must have fewer than 250 employees;
- The company must be independent (no other person or company can exercise direct or indirect control over the company’s affairs);
- The company can only have qualifying subsidiaries;
- The company must be a trading company carrying out a qualifying trade. It is important to note, numerous activities are excluded from the term qualifying trade.
- The company must have a permanent establishment in the UK.
- The employee must work at least 25 hours a week (or 75% of working time) for the company or a member of its group;
- The employee must not hold a material interest, either alone or with associated parties (spouse, children, business parties) in the company ie 30%.
How are EMI options exercised?
How options are exercised by employees is detailed in the scheme rules, which can be tailored for each company and its needs and business aspirations. Specific criteria will need to be met before exercise is allowed, for example once a specific target or date has been met, or on an exit, such as the sale or listing of the company. Companies can use these targets to encourage and promote certain behaviors, or drive growth and build value in certain areas of the business.
Tax and national insurance considerations
When options are awarded, employees are not required to pay for the shares. This only happens when the options are exercised, and the price payable will be the agreed price set at the start of the contract. If the company’s share price has increased in value between the time of grant of option and the time of exercise, the uplift is not charged to income tax. Instead, this gain will be subject to the lower capital gains tax (CGT). This may be taxed at entrepreneurs’ relief rates of 10%, provided that the shares (or option) have been held for at least one year, and the employee remains an employee or director at the time of exit. This is advantageous to the employee as it negates the need to hold a 5% shareholding in the company, which would usually be required to qualify for entrepreneurs’ relief.
In some circumstances tax can become chargeable on exercise of the option, especially if the option were not part of a tax advantaged EMI scheme. Therefore, careful drafting is needed and advice should be sought to make sure any scheme created is EMI compliant.