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Zeeshan Khilji discusses how the Enterprise Management Incentive (EMI) scheme can be a great way for businesses to reward, motivate and retain employees in the current economic climate.
The government announced its COVID-19 roadmap in February 2021 with a view to easing lockdown restrictions, setting out a phased approach to re-opening businesses. Over the next few months, business owners will need to retain and reward key staff in order to help their businesses recover from the impact of the COVID-19 crisis. With limited cash resources, many businesses would be unable to incentivise employees adequately on a cash basis.
The EMI share option scheme allows employers to reward employees in a tax efficient manner, without causing a significant drain on the cash flow of the business.
How does an EMI scheme work?
The primary benefit of the EMI scheme is that options over shares can be granted to key members of staff at today’s value, which can be agreed with HMRC in advance. Provided the exercise price (i.e. the price which the employee pays for the shares upon exercising the options) are at least equal to the market value of those shares at the date of grant, there are no income tax or NIC implications for the employee.
Assuming the company grows in value and the employee stays with the company, the growth in value can usually be ‘protected’ from an employment income tax charge and would instead only be subject to capital gains, with the capital gains tax arising only when the employee subsequently disposes of their shares.
The current main rate of CGT is 20% which is substantially less than the effective rate of employment taxes and if the employee has held options for more than two years, gains up to £1 million are taxed at a rate of 10% provided certain conditions are met.
An EMI option can therefore be exercised at a point in the future, which is usually set as:
1. When a sale of the company occurs; or
2. When certain performance or other criteria are met.
The first step for the company is to agree a valuation with HMRC prior to the grant of share options. As the shares are usually in respect of a minority shareholding in the company, HMRC generally accept that those shares are heavily discounted (as much as up to 80% in some cases).
Further, the economic downturn as a result of the pandemic has had a negative impact on the trading performance of many companies with the result that that the market values of company shares have fallen significantly. This has meant that new EMI options can potentially be granted to employees at much lower prices than before.
There are certain criteria that both employers and employees must meet in order to qualify for EMI option status. In practice, most family and owner managed businesses should be able to put EMI options in place.
Some of the key criteria are as follows:
The option holder (the relevant employee) must:
1. Be an employee of the company or the group;
2. Work 25 hours a week or if they work less than 25 hours, at least 75% of their total working time;
3. Not have a material interest (i.e. a 30% or more equity interest) in the company already, together with their associates.
1. The company issuing the EMI options must not be a subsidiary of another company;
2. The company must not have net assets of more than £30 million;
3. The company must not have more than 250 employees;
4. Broadly, it must be a trading company;
5. There are also certain limits on the total value of EMI options which are allowed to be granted.
Reporting and notification
There are certain reporting requirements which need to be met. Further, a notice of each option grant must be submitted on-line to HMRC within 92 days of the grant for each employee.
While HMRC might be sympathetic to cases where the filing was delayed due to the impact of the COVID-19 pandemic, the notification process is critical as failure to give the relevant notice within the 92-day period will invalidate the relevant EMI options, which could have disastrous tax implications for the employees.
In January 2015, A Ltd granted the following EMI options to three of its key employees:
All EMI options were to be exercised on a future sale of the company at their agreed market value of £10 per share in January 2015 (i.e. date of grant).
In January 2021, A Ltd was acquired by B Ltd. Immediately before the sale was completed, all three employees exercised their options.
The agreed sale consideration paid to all the shareholders of A Ltd was £20 per share.
The capital gains of the EMI shareholders (on the assumption that they are higher-rate taxpayers) are computed as follows:
The employees have exercised their EMI options, paying the market value as at the date of grant. This means that the entire growth in the value of the shares from grant date falls within the Capital Gains Tax regime and the share disposal qualifies for Business Asset Disposal Relief (on the assumption that all the relevant BADR conditions are met).
By way of comparison, if the options had been unapproved, virtually all of the value of the shares at the date of sale would be subject to significantly higher income tax and NIC.
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