Enterprise Management Incentives
The Enterprise Management Incentives (EMI) scheme is a tax–favoured share option scheme targeted at smaller, entrepreneurial companies.
What is the EMI?
The EMI is a share option scheme aimed at small entrepreneurial companies that meet certain conditions. It has been designed to assist such companies to recruit and retain both directors and employees, this factsheet will refer to ‘employees’ for simplicity. The scheme offers attractive opportunities for equity participation by employees in recognition of the fact that smaller companies may not be able to match salary levels paid elsewhere. The Enterprise Management Incentives scheme is also flexible enough to allow for the option share to be geared to future capital growth, and performance targets to be used in the scheme.
The rules have been designed to provide as much flexibility as possible and enable different arrangements to be put in place for each participant.
What companies can offer EMI options?
To qualify to offer EMI options to employees, a company can be quoted or unquoted but must meet all the following qualifying conditions at the time the options are granted (and some must also continue to be met subsequently). These conditions are that the company must:
have gross assets of no more than £30 million (or if it is a parent of a group, the group’s assets must not exceed £30 million) – gross assets of a company are all those shown on the balance sheet drawn up in accordance with standard accounting practice
not be under the control of any other company
operate a qualifying trade. Non–qualifying trades include property development, leasing, hotels, nursing homes, banking and other financial activities, legal/accountancy services, farming and from 21 July 2008, shipbuilding, coal and steel production
carry on its trading activities wholly or mainly in the UK, although the company does not have to be resident or incorporated in the UK
have only qualifying subsidiaries. A subsidiary is ‘qualifying’ if the company owns more than 50% of its ordinary share capital (or, in the case of a property managing subsidiary, at least 90% of issued share capital and voting, capital and income rights)
have less than 250 employees from 21 July 2008.
In a group of companies, the business of the group as a whole must not consist wholly, or as to a substantial part, of nonqualifying trades, and at least one group company must carry on a qualifying trade wholly or mainly in the UK.
Who is an eligible employee?
The selection of EMI option holders is largely left to the employing company, although some basic conditions apply. An individual can be eligible provided he/she:
is an employee of the company granting the options, or of a subsidiary company
works at least 25 hours a week for the company or group or, if less, 75% of his/her working time
does not have a ‘material interest’ in the company or, if the company is the parent of a group, a material interest in any of the group companies. Material interest is defined as being able to control more than 30% of the ordinary share capital of the company.
How does the scheme operate?
Administration of the EMI has generally been kept to a minimum. Employers do not need formal approval of a scheme but have to notify HM Revenue and Customs (HMRC) within 92 days of the options being granted. HMRC has 12 months from the expiry of the 92 days to begin enquiries to check that the grant meets the Enterprise Management Incentives scheme rules.
Directors of companies and their agents are able to apply to HMRC to obtain advance assurance that they meet the conditions for a ‘qualifying company’.
For every option granted, there must be a written agreement between the company and the employee specifying:
the date of the grant and that the options are granted under the provisions of the EMI
the number, or maximum number, of shares under the EMI option
the price at which the shares may be bought – often likely to be, but not necessarily, the market value at the date of grant of the option
when and how the option is to be exercised
details of any restrictions or conditions attaching to the shares together with any performance requirements.
An annual return must be submitted within three months of the end of the tax year (even if no options were granted or exercised during the year) and any share valuations in connection with EMI shares will, at some point, be subject to formal approval by HMRC.
What is the tax treatment of the options and the shares acquired?
No tax or national insurance (NI) will be payable on the grant of the option.
Provided that the options are exercised within 10 years of the date of grant, and, if the price at which the employee can exercise the option is at least equal to the market value of the shares when the option is granted, no tax or NI is charged.
If the options are ‘nil cost’ or ‘discounted’ options, there will be an income tax (and NI, if the shares are readily convertible into cash) charge on the difference between the amount paid for the shares on exercise and the market value of the shares at the date of grant (ie on the element of the discount).
If there is a charge to NI, it is possible to transfer the employer’s NI liability to the employee, who can obtain income tax relief on the payment.
Capital gains tax (CGT) is chargeable on the profit element on the sale of shares acquired following the exercise of EMI options. From 6 April 2008, CGT is charged at a flat rate of 18%. This may be reduced to an effective rate of 10% if the shareholding meets the qualifying conditions for entrepreneurs’ relief. However, as the conditions require holding at least 5% of the ordinary share capital for a minimum of one year prior to disposal of the shares, it is unlikely that many EMI shareholders will qualify for the relief.
The shares that can be acquired under the option must be fully paid–up ordinary shares that cannot be redeemable or convertible. However, unlike other approved share schemes, the shares may be subject to restrictions, eg limited voting rights and pre–emption rights.
Generally, if shares acquired by employees have employment related restrictions over them, an income tax charge may arise on a proportion of the gain on sale. However, in the case of EMI options, the shares acquired should not suffer this charge (provided they are not ‘discounted’ options).
Limits on options
The maximum value of tax–favoured EMI options that can be granted is £120,000 per employee from 6 April 2008, reduced where the employee holds unexercised options granted under an HMRC approved Company Share Option Plan (CSOP). The maximum value of EMI options that a company or group can grant is £3 million. Where the value of an employee’s options reaches £120,000, no further qualifying options can be granted for three years, and after that only if some or all existing options have been exercised.
Loss of tax benefits
The tax reliefs can be lost in certain circumstances, if for example, before the exercise of an option:
the company ceases to carry on a qualifying trade or is taken over by another company
an employee no longer meets the working time requirement
an employee is awarded options under a CSOP that take the market value of shares subject to EMI and CSOP options over £120,000
a variation is made to the terms of the option, the effect of which is to increase the market value of the shares under option, or which renders the option non–qualifying under the EMI legislation.
For the right type of company the Enterprise Management Incentives scheme can help recruit and retain high quality staff. However, it should be ensured that it satisfies both the employer’s and the employees’ needs.