Reshma Johar provides a helpful checklist for company owners when considering enterprise management incentives for employees.
Of the four types of approved share schemes, the enterprise management incentives (EMI) scheme offers both flexibility and discretion in its use. It was originally introduced to incentivise and retain key employees (but excluding contractors).
Both option holders and the employing company benefit from various tax advantages.
How flexible is ‘flexible’?
A company can decide who the options are awarded to, what the option price will be, what the terms or targets should be (if any), and when the options can be exercised.
EMI mechanics
- The employer company will grant options to key employees. There is no tax impact for both employee and employing company.
- Options are exercised (i.e., shares are acquired) by key employees. For the employee, there is taxable employment income if the exercise price was lower than the market value at the date of grant. The employing company can generally claim a corporation tax deduction on the difference between the market value of the shares at the date of exercise and the actual price paid by the employee.
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Future sale of shares by the key employee - If two years have passed from date of grant of the option, any gain is generally subject to capital gains tax at 10% by claiming business asset disposal relief (BADR).
Company conditions
- Size of company - Consolidated gross assets of the company (or group of companies) must be less than £30 million.
- The company (or group) must have less than 250 employees.
- Qualifying trade – The trade must not be substantially of an excluded activity. The list of excluded trading activities is the same as for venture capital schemes; examples include banking and property development.
- A company must not be under the control of another company.
- If a company controls another company, it must be a qualifying subsidiary.
- The issuing company (or another group company) must have a UK permanent establishment.
- The granting of the options must be over ordinary shares.
- The maximum value of unexercised options under EMI is £3 million.
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The options must be granted for commercial reasons, and not as part of an arrangement, one of the main purposes of which is to avoid tax.
Employee conditions
- The ‘working time’ requirement must be met - This is 25 hours per week or where the employee spends at least 75% of their working time at the relevant company. This condition will be treated as being met for options granted before 19 March 2020 if the condition would have been met had they not been impacted by the Covid pandemic.
- The maximum value of share options which can be held is £250,000 based on the market value at date of grant.
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An employee cannot hold more than 30% of the share capital.
Beware the pitfalls!
The following could trigger a disqualifying event:
- The company is either taken over or ceases to be a trading company.
- The employee ceases to meet the working time requirement (but see the above exception).
- The employee leaves the employment.
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Changing terms of the options or shares, which impact the market value or results in the options no longer qualifying.
Next steps
Once the scheme terms have been established, the employer company should appoint a solicitor to draft the contracts which would outline the terms. It may be necessary to appoint an expert to value the shares as there are several different approaches which can be taken.
Finally, once implemented, notifications to HMRC will be required under the employment-related securities regime. Since the pandemic, the deadline to notify the grant of options has been extended.
Practical tip
If there is doubt over whether there is a qualifying company, it is possible to obtain advance assurance from HMRC.
