Considerations when setting up an EMI scheme

Enterprise Management Initiative (EMI) schemes can be a great way of recruiting, retaining and incentivising key staff. Whilst offering employee share options is particularly popular with younger entrepreneurial companies, they can also be helpful for more established businesses.

EMI scheme benefits

EMI schemes offer very favourable tax treatment to employees through granting options to them. They entitle them to acquire shares at a later date, by exercising their options. No income tax or NIC is payable at the time when the options are granted.

Provided that the “exercise price” at which the employee can buy the shares is not less than their market value at the time when the options were granted, there is also no income tax or NIC charge when the options are exercised. This means there’s no income tax or NIC on the uplift in market value. In contrast, any such gain arising on non-EMI options would be subject to income tax at rates ranging from 20% to 45% and, in certain circumstances, this must be accounted for under PAYE along with the associated employer and employees’ NIC.

The terms of the options can be flexible allowing them to be geared to future capital growth. Performance targets may be used in the scheme and the rules enable different arrangements for each participant.

On the exercise of the shares, the company can claim a deduction against its taxable profits of the difference between the market value of the shares at exercise less the price paid by the employees. This provides a useful tax relief for companies that implement an EMI scheme.

In addition, by being able to retain key employees and avoid the necessity of finding replacements, the high cost of paying recruitment fees can be avoided.

Considerations when setting up an EMI scheme

Here are five things to consider when setting up an EMI scheme:

1. Limitations

The EMI is currently limited to trading companies with up to £30 million in gross assets and 250 employees. The company which grants the options must not be controlled by any other company – although groups of companies can still operate EMI schemes, as long as the options are granted by the top company in the group. There are also certain ‘excluded activities’ that can prevent an employer from being able to offer EMIs – these include banking, property development, legal services, farming and shipbuilding.

2. Option price and conditions

In order to provide certainty for employees over their tax position, it is recommended that the market value of the shares should be agreed with HMRC before the options are granted. While granting options at a discount on market value leads to an income tax charge on exercise, it’s certainly open to employers to do this and they may, for example, wish to use nominal value of the shares in some cases.

3. Employee incentivisation

On selling their shares, the employee is liable to capital gains tax (CGT) – generally at 20% of the gain – and, if not already used, they can use their annual CGT exemption which is currently £6,000 but will reduce to £3,000 from 6 April 2024. The employees may be eligible for Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) and reduce the rate of CGT to 10%. It is common for employees to fund the option exercise price by selling the shares straight away. Many schemes are “exit only” schemes which allow employees to exercise only on certain major events such as a sale of the business. In addition, employers can incorporate performance milestones, to be achieved before options can be exercised.

4. Costs and benefits

From a company perspective, there is usually a tax deduction when employees exercise their options, based on the difference between market value and the price paid for the shares. Although there are fees for setting up the scheme, ongoing running costs are modest. There is a requirement to notify HMRC each time options are granted. In addition, the scheme must be registered, online, with HMRC when it is set up, and a return must be submitted each July.

5. Qualifying employees

Qualifying employees must work for the company at least 25 hours each week, or for at least 75% of their total paid working time (including self-employment). Each employee can hold unexercised options worth up to £250,000.

At Carpenter Box we provide a full EMI implementation and management service that includes valuation, review, documentation, filing and exercise. We can also offer a meeting to help roll out the EMI options to employees and explain what they are signing, how the option works and what they need to do. For further information or advice on EMI schemes, please get in touch with a member of our business tax team at www.carpenterbox.com