The EMI legislation was introduced back in 2000 but remains a key method for trading companies or groups to recruit, retain, motivate and incentivise key directors and employees via the use of tax advantaged share options.
Giving employees and directors shares in their employing company has long been regarded as a sensible means of aligning their interests with those of the company’s shareholders. But a straightforward “unapproved” acquisition of shares in an employee or director’s employing company can often result in complications from an income tax and NIC perspective. In the case of unquoted companies, the valuation of shares for employment tax purposes is not a straightforward matter and often sparks debate with HM Revenue & Customs who are understandably keen to tax the value of shares acquired by directors and employees as “employment reward”.
In view of the above, companies have increasingly been making use of the HMRC approved employee share schemes EMI options as a means of facilitating employee share acquisition.
The key qualifying criteria for the use of EMI options remain. The company granting the EMI option must not be under the control of another company and must have gross assets of less than £30m and fewer than 250 full-time employees. As with the EIS legislation, companies carrying on certain excluded trades including property development, farming or leasing are not eligible to grant EMI options. The director or employee who is granted the option must be an “eligible employee” i.e. work for the company in remunerated employment for at least 25 hours per week or, if lower, at least 75% of their working time.
In practice, however, most companies and employees will be able to meet the above criteria and access the key tax benefits of this tax-advantaged HMRC share option scheme which are detailed below: -
Key tax advantages
• The company granting the EMI option is able to agree the tax market value of the option shares with HMRC in advance of the option being granted. This eliminates the tax uncertainty that exists whenever employees or directors acquire shares in their employing company outside the scope of an HMRC approved share scheme. The tax value as agreed with HMRC can be relied upon for up to 10 years from the date of grant even though the market value of the option shares may increase dramatically in the period between grant and exercise;
• Where the option is granted with an exercise price that is not less than the market value of the shares at the date of grant, the gain on exercise of the option will be exempt from income tax/PAYE and NIC;
• When the option is exercised, the employing company is entitled to claim a corporation tax deduction, as a trading expense, for the difference between the market value of the shares at the date of exercise less the exercise price paid. If exercise takes place at a time when the company is about to be sold to a third party purchaser, the corporation tax deduction and hence saving may be significant. In some cases the vendor shareholders will seek to retain the benefit of the corporation tax saving by negotiation with the purchaser;
• A chargeable gain made by an option holder on the sale of shares acquired on exercise of an EMI option will be eligible for CGT Entrepreneurs Relief and the 10% CGT rate provided at least 12 months elapse between the date on which the option is granted and the date on which the shares acquired on exercise of the option are sold. This will be the case even if the EMI option is over an ordinary shareholding that is lower than the normal 5% threshold that applies before CGT Entrepreneurs Relief can be claimed.
Potential scenarios for the use of EMI options
The EMI legislation facilitates the use of EMI options in a number of different commercial scenarios and circumstances.
For example, an established company could grant EMI options to selected employees and directors to retain them in the period leading up to a sale of the company and reward them with a tax efficient lump sum.
Alternatively, a start-up company could grant EMI options to bring key directors and employees on board. The company may not have the cash resources to pay market rate salaries and the founder shareholders may be willing to give up some equity in the company to entice individuals to join and enable them to share in the future capital growth of the business.
Thirdly, a company may grant EMI options as part of a succession strategy under which the existing shareholders will exit and control of the company will pass at a later date to the management team under a management buy-out.
Thomas Westcott can provide tax and share valuation advice and assistance in connection with the grant of EMI options and will work with you and your lawyers throughout the process from design through to final implementation.
For further advice, please contact me or your local Thomas Westcott office.
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