Published Summer 2013
An enterprise management incentive share option (EMI option) is a tax advantageous employee share option scheme granted by qualifying trading companies to selected employees (typically key employees and senior management).
Following the 2012 Budget, EMI share option schemes have seen a resurgence in popularity. This is because the capital gains tax (CGT) payable on a capital gain made on the sale of shares acquired via an EMI option will now often qualify for Entrepreneur’s Relief (this reduces the effective rate of CGT to 10%).
Before the 2012 Budget most shares acquired by employees through an EMI option did not qualify for Entrepreneur’s Relief unless the relevant employee held more than 5% of the shares for at least one year prior to selling them.
An EMI option gives an employee the right, but not the obligation, to acquire shares in his employing company. Normally, the employee has the right to exercise the option at a defined price (exercise price) at a particular point in time or upon the occurrence of a certain event (such as a sale or listing of the company) or when certain performance targets have been met.
The EMI option legislation is specifically targeted at small, higher-risk trading companies in order to help them recruit and retain staff. Whilst the tax advantages of EMI options make them attractive, they can also be a cost effective way of remunerating and incentivising key employees. The EMI legislation requires that EMI option terms take the form of a written agreement which states the main terms of the option including how and when it may be exercised. EMI options may be granted under a set of plan rules, or by way of stand-alone EMI option agreements.
EMI Share Option Tax Advantages
There is no income tax liability on the grant of an EMI option. There is no income tax or national insurance (NICs) liability when the employee exercises the option, if the exercise price is at least equal to the market value of the shares at the date the option was granted. If the exercise price is less than the market value as at grant, then income tax and NICs are payable on the difference between the exercise price and the market value at grant. If the market value of the option shares increases between the date of grant and exercise of the option, there is no income tax or NICs liability on that increase in value and such increase is liable only to CGT (which may be as low as 10% if Entrepreneur’s Relief applies).
The tax advantage of an EMI option can be contrasted with the tax treatment of an unapproved share option scheme. With an unapproved scheme, income tax and NICs are payable on this difference between the market value of the shares at the date of exercise and the exercise price (the market value of the shares at the date of grant of the option has no bearing on the tax calculation).
Shares acquired on the exercise of EMI options on or after 6 April 2012 and disposed of on or after 6 April 2013 can potentially qualify for Entrepreneur’s Relief, irrespective of the size of the relevant shareholding. To qualify for Entrepreneur’s Relief, at least 12 months must have elapsed between the date the option is granted and the date of the sale of the shares, in addition to the other company status and employment conditions required to claim Entrepreneur’s Relief.
Aside from the tax advantages, there are a number of other potential benefits that can be derived from the implementation of EMI share option schemes. Employees are offered the opportunity to participate in the growth in the value of the company which their hard work may help to create. This is an effective way to engender loyalty and long service amongst key employees. EMI options are normally stated to lapse when an employee leaves his employer or, at the latest, within 6 months of the date he/she leaves.
EMI Qualification Rules
In order to be an EMI option the following rules must be complied with:
- The employer must be a qualifying trading company with less than the full time equivalent of 250 employees and gross assets of £30 million or less (foreign companies can also qualify);
- It cannot be a subsidiary company (usually EMI options are granted by the ultimate holding company where there is a group of companies);
- The maximum value of awards permitted under the scheme are £250,000 per employee and £3 million per company (valued at the date of grant). There is no limit on the number of participating employees;
- An employee must work for the company for at least 25 hours per week or, if less, 75% of his/her working time;
- The option must be capable of being exercised within 10 years of the date of grant and cannot last for more than 10 years;
- Qualifying trading companies are trading companies not carrying on disqualified trades (disqualifying trades include dealing in land, securities or commodities, property development and leasing/hiring businesses);
- Employees with more than 30% of the ordinary share capital of the company cannot participate; and
- HMRC must be given notice of the grant of an EMI option within 92 days of its grant.
Exercise of an EMI Option
Companies have a high level of flexibility when setting the terms of their EMI options. Careful consideration should be given to the circumstances in which the employee can exercise the option. Often, EMI options are structured on the basis that they can only be exercised by the employee if there is an exit event such as a sale of the company or its trade to a third party or a listing of the company’s shares. The employee can then participate in the resulting disposal gain. Structuring the option in this way means that control of the company and any shareholder arrangements (e.g. shareholders agreement and/or the Company’s articles of association) are unaffected until such time as an exit event is about to or has taken place.
Where it is intended that employees should have the opportunity to become shareholders once a certain period of service has been achieved or certain personal performance targets have been met, these requirements can be expressed in each individual EMI option agreement. The option may, for example, be exercisable after a certain number of years’ service or the option may be exercisable in tranches according to completed periods of service and/or when certain financial targets have been met by the employee and/or the company.
If EMI options can be exercised by the employee after a period of service and/or when performance targets are met, careful consideration should be given about the impact that this will have on the company’s articles of association and any necessary changes should be made to the articles at the time of or before the options are granted. If an employee acquires shares before an exit event, then the articles should require him to offer his shares for sale to other shareholders, the company or an employee benefit trust at a defined price when he leaves the company and a “drag-along” provision should be included in the articles so he/she can be required to sell his/her other shares if and when there is a later general exit.
A well designed EMI scheme can provide a simple and valuable way of rewarding future success. However, such schemes are only appropriate in the right circumstances. Before implementing such a scheme, a company should consider the variety of ways that incentivised remuneration can be achieved. Due to the complexity of the issues which need to be considered when planning an EMI option scheme, it is essential to get specialist legal and accounting advice at an early stage.
If you are seeking legal advice regarding an EMI share option scheme then please contact our specialist solicitors on 0161 941 4000.
Alternatively you can use the enquiry form found on the right of this page and we will contact you at a suitable time.