Enterprise Management Incentives (EMI)
What are Enterprise Management Incentives?
All companies able to use EMI options should give serious thought to this flexible, government-backed incentive scheme.
Ambitious smaller companies need a way to compete with large, established businesses for talented employees. EMI allows such companies to grant share options – a right to acquire shares in the future, at a fixed price – to key employees on a tax-advantaged basis, so that employees who invest their time and efforts in the company can benefit along with shareholders on a future exit or other realisation event.
EMI has been expanded since its inception and is now available to trading companies with no more than 250 fte employees and gross assets of no more than £30m. There are also other requirements detailed below.
Why is EMI so widely used?
The main attractions are:
- Flexible, discretionary incentives – companies are free to specify the circumstances in which employees will be able to exercise (or lose) their options, to create the right motivations for employees.
- Share options allow employees to benefit as shareholders on an exit, but without creating the complications associated with minority shareholders in the meantime before exercise. For smaller companies, “exit-only” EMI schemes are very easy to keep running once set up.
- Tax-advantaged treatment means that for “market value” EMI options, there is:
- no income tax (or NICs) on exercise; and
- employees benefit from the 10% “Entrepreneurs’ Relief” rate of capital gains tax on a sale of the shares acquired, as long as the sale is at least two years after the option grant (regardless of whether they hold less than 5% of the company); but
- employers will still have the full benefit of corporation tax relief on the gain received by the employee on exercise.
- HMRC will agree share valuations for the purpose of EMI awards in advance, allowing certainty for companies as to the future tax position. Often these valuations will be at a significant discount to take account of the small holdings EMI is usually granted over and the likelihood that any sale is some way down the line.
“Ordinary” shares must be used, but these can be subject to restrictions. EMI options can be granted over “growth shares” if these are used. They can be newly-issued shares, or shares held by an existing shareholder or a vehicle such as an employees’ share trust.
Who qualifies for an Enterprise Management Incentive?
The company whose shares are put under option (“the plan company”) must be an independent company with gross assets of less than £30million and the plan company, or group, must have fewer than 250 employees (full-time equivalent).
Any subsidiaries of which the EMI company has control must be 51% subsidiaries or, in the case of a property company, a 90% subsidiary.
The activities of the EMI company, or group, must not consist as to a substantial part of non-qualifying activities. These include:
- dealing in land, commodities, futures or shares etc;
- dealing in goods otherwise than in the course of an ordinary trade of wholesale or retail distribution;
- banking, insurance and other financial activities;
- leasing and hiring;
- receiving royalties or license fees (save in respect of intellectual property created by the company or group itself);
- legal or accountancy services;
- property development;
- farming or market gardening;
- forestry, woodlands or timber production;
- shipbuilding, coal or steel production;
- managing hotels etc;
- managing nursing or residential care homes; or
- acting as a “service company” in providing any such activities to an associated business.
To be eligible to be granted an EMI option an individual must be:
- a “full-time” employee who is committed to spending at least 25 hours per week, or, if less, 75% of his or her working time to the business of the group; and
- must not have, or be deemed to have at the time of grant, a “material interest” (30%) in the EMI company.
Limits on the grant of EMI options
There is an individual limit, of £250,000, on the total initial market value, as at the date(s) of grant, of the shares over which EMI options may be granted to an eligible employee. The value of any shares over which CSOP options are held by the individual are counted towards this limit.
There is also an overall limit of £3 million on the total initial market value of shares in a company over which unexercised EMI options may be held by all employees.
Notification of grant to HMRC
It is vital that the grant of the option is notified to HMRC online within 92 days in order to qualify for EMI tax treatment.
The occurrence of a disqualifying event will limit the amount of gain on which tax relief is given as, unless the option is exercised within 90 days after the occurrence of such an event, any growth in value accruing after the event will not qualify for relief.
EMI options may be drafted to lapse and be cancelled on a disqualifying event. It is important to be aware that if full tax relief is not available, this may in some circumstances lead to PAYE and National Insurance liabilities, so there will be costs for the company as well as the employee.
“Disqualifying events” include:
- a loss of independence of the company (although options may sometimes be exchanged for replacement EMI options on a reorganisation with no loss of accrued tax relief);
- the EMI company ceasing to meet the trading activities test;
- the optionholder ceasing to be an eligible employee;
- the optionholder not having, at the end of a tax year, actually met the “commitment of time” test;
- the option terms being varied so as to increase the value of the shares under option or so that they cease to meet the statutory requirements;
- the share capital of the EMI company being altered in certain specified ways;
- the optionholder being granted a CSOP option taking them above the individual limit of £250,000; or
- the EMI company, having qualified as preparing to carry on a qualifying trade, not actually doing so within 2 years.
How Pett Franklin can help
Contact us if you would like to speak to us about EMI and how they might be able to help you or your client.
The Enterprise Management Incentive regime was intended to allow commercial flexibility, and it does. There is no period which must elapse before the option is exercised, and no requirements as to the minimum exercise price or as to when the option must be exercised.
Relief from income tax and NICs is afforded to the whole, or part, of the gain in market value of the option shares realised upon the exercise of a share option granted by a qualifying company to an eligible employee. CGT is charged on any gain on sale of the option shares by reference to the exercise price paid (and any amount on which relief from income tax was not available at the time of exercise of the option). If all relevant conditions set out in the Corporation Tax Act 2009 are met, relief from corporation tax for the amount of gain realised upon exercise of an EMI option should also be available to the employer company. From 6 April 2013, shares acquired upon the exercise of an EMI option will also qualify for Entrepreneur’s Relief from CGT (a reduced rate of 10%) on disposal, regardless of the percentage of the ordinary share capital they represent, provided that disposal takes place at least 12 months after the grant of the option.
The combination of reliefs means that EMI share options are currently the most attractive mechanism for a small company seeking to enable key employees to benefit from growth in value in a tax-efficient manner. A company which qualifies to grant EMI options should always consider doing so before looking at any alternatives.
However, the relief is only given in respect of any gain representing growth in the market value of the option shares from the date of grant to the date of exercise or, if it occurs more than 40 (to be 90) days before the date of exercise, the occurrence of a “disqualifying event”. Any amount by which the exercise price is less than the market value of the option shares at the time of grant is charged to income tax at the time of exercise. For this reason, it is always desirable (although not strictly necessary) to determine and agree with HMRC Shares and Assets Valuation at or before the time of grant exactly what is the “market value” of a share in the EMI company as at the time of grant. Such a valuation agreement will also ensure that EMI options are granted within the individual and overall limits referred to below.
The company whose shares are put under option (“the plan company”) must be an independent company with gross assets of less than £30million and the plan company, or group, must have less than 250 employees (full-time equivalent). Any subsidiaries of which the EMI company has control must be 51% subsidiaries or, in the case of a property company, a 90% subsidiary. The activities of the EMI company, or group, must not consist as to a substantial part (20%) of non-qualifying activities. We can help you identify whether your company engages in any non-qualifying activities.
To be eligible to be granted an EMI option an individual must be a director or employee of the EMI company or of a qualifying subsidiary who is committed to spending at least 25 hours per week, or, if less, 75% of his or her working time to the business of the group and must not have, or be deemed to have at the time of grant (only), a “material interest” (30%) in the EMI company.
Limits on the grant of EMI options
There is an individual limit, of £250,000, on the aggregate initial unrestricted market value, as at the date(s) of grant, of the shares over which EMI options may be granted to an eligible employee (or director). The value of any shares over which CSOP options are held by the individual are counted towards this limit. There is also an overall limit of (currently) £3 million on the aggregate initial unrestricted market value of shares in a company over which unexercised EMI options may be held by all employees.
Nature of the option
The option must take the form of a written option. Exercise of the option may be performance-linked, but it must be capable of being exercised, if at all, within 10 years (and relief is not available if it is exercised after more than 10 years from grant) and must not be capable of exercise (by personal representatives) more than 12 months after the death of the optionholder .
Notification of grant to HMRC
It is vital that the grant of the option is notified to HMRC Small Companies Enterprise Centre within 92 days on the form available at Form EMI1 – Notification of grant of an EMI option, as it will not otherwise qualify as an EMI option.
The occurrence of a disqualifying event will curb the amount of gain on which tax relief is given as, unless the option is exercised within 40 (to be 90) days after the occurrence of such an event, any growth in value accruing after the event will not qualify for relief. Common “disqualifying events” include: a loss of independence of the company (save in the event of a takeover if the option is exchanged), the EMI company ceasing to meet the trading activities test or the optionholder ceasing to be an eligible employee.