EMI schemes

The Scheme grants employees the option/right to buy a set number of shares in their Employer company at some point in the future at a set price. All details are clarified upfront so both the employee and the employer will have an understanding of how many shares they can buy, at what price, and when.

The terms of the scheme are generally quite flexible and can be drafted to suit your requirements and tailored to mitigate your concerns.

What would be the reason for putting an EMI scheme in place?

The scheme is designed to recruit, retain and incentivise employees whilst still allowing you, as the employer, to maintain control of the company. They are therefore used in a variety of scenarios, from an ‘exit-only’ option entitling employees to a share of the proceeds when the company is sold, to ensuring performance targets are consistently met or simply, to enable employees to share in dividend payments.

It is also frequently used by employers in retirement planning as the ‘first step’ in handing the company over to the management team. It is however particularly relevant for smaller fast-growing private companies who want to retain their core staff as to maintain consistency and growth.

What is the grant of the option?

The grant of the option is when the EMI option agreement is initially signed. It gives the employee the right to acquire shares in the company at some point in the future.

What is vesting?

Following the grant of an option, before an employee has the right to exercise their shares (see below), sometimes conditions are attached to the EMI scheme, for example a duration of time, or performance targets set. When these thresholds are met, the employee is then ‘able’ to exercise their options. Whilst they may not do so immediately, the vesting point is when the options become ‘exercisable’.

What is exercise?

Exercise is when the employee actually takes up their ‘right’ to purchase shares in the company and then acquires the shares.

You mentioned this is a tax advantaged scheme – what are the tax benefits?    

When an employee receives shares, if they do not pay full market value for those shares, they have received shares at a discount. This is considered to be a benefit and is subject to income tax as remuneration in kind. This is very similar to the way a Company Director may receive benefits, for example a company car benefit will be subject to income tax.

A key aspect of an EMI scheme is that the employee will pay income tax based on the value of the shares at the grant of the option (i.e. when they are initially given the ‘right’ to buy shares). Ordinarily, under a non-taxed advantaged share scheme, this income tax charge is based on the market value when the shares are exercised. Therefore, under an EMI scheme, hopefully the value of shares has increased between grant and exercise with the increase in value not being subject to income tax.

There are also some capital gains tax benefits attached to an EMI scheme where the employee can claim Business Asset Disposal Relief (“BADR” – formerly known as entrepreneurs’ relief) where they have held their share option (not the shares themselves) for a minimum of two years. There is also no minimum % shareholding requirement so most employees should be able to benefit from BADR when the shares are ultimately sold. A claim for BADR affords a lower capital gains tax rate of 10%.

As noted previously, exit-only options (i.e. a scheme where shares are only able to be acquired immediately prior to a company sale) are a common type of EMI option. If exit-only share options were granted now and the employee was required to pay today’s market value for their shares when they exercise, this means that no ‘benefit’ has arisen for income tax purposes and so no income tax would be due on exercise.

For example, in 5 years’ time, if the employee exercises their options, the shares would then be acquired and immediately sold and the employee would essentially receive their share of the sale proceeds, less the exercise price. The growth in value of the shares from grant to exercise would be subject to capital gains tax only. Providing the relevant conditions for BADR have been met, this may only be taxed at 10%.

No national insurance (employee or employer) would be due in this example either so, as you can see, this mechanism would be far more tax efficient than simply paying a bonus.

Corporation tax relief would also be available on any discount given to the employee when they exercise their options. The difference between the market value and the amount paid is tax deductible in calculating taxable profits.

As with any tax-advantaged arrangement, there are various conditions that need to be met from both the employee and employer/company perspective.

EMI share scheme rules - what conditions does the company have to meet to be eligible for an EMI scheme?

There are various conditions to meet in order to be a qualifying EMI scheme. We can discuss this with you in more detail and ensure that all points relevant to your company are considered. Please see below a list of the most common conditions which affect eligibility:

• Gross assets of the group must not exceed £30million
• Employees must not exceed 250 full time equivalents
• Must have a permanent establishment in the UK
• Must carry on a commercial trade that does not substantially consist of ‘excluded activities’
• All subsidiary companies must be ‘qualifying’
• The options must be over shares in the Top Company of a group
• EMI options totalling up to a maximum of £3m

Companies that work in excluded activities do not qualify and cannot issue EMI options. These include banking, finance, insurance, property development, provision of legal services, ship building etc.

If there is uncertainty as to whether your company’s trade constitutes a qualifying activity, or it may not meet one of the other qualifying conditions required for EMI, we can assist you in obtaining an advance assurance from HMRC. This confirms the qualifying status of the company prior to granting the share options.

EMI share scheme rules - do the option holders need to meet any conditions to qualify under the EMI scheme?

Yes – the option holders will need to meet a number of conditions. These are largely based around their employment, the first of which being that they are, in fact, employees of the company and not just subcontractors or consultants. The individuals must be on the payroll scheme of a group company.

Each employee must also meet the working time requirements throughout the period between grant and exercise, i.e. they must work for the company or a qualifying subsidiary for at least 25 hours per week, or 75% of their total working time (if less). Practically, it is very unusual for this requirement to be an issue.

The employee must also not hold more than 30% of the issued share capital of the company (i.e. have a material interest) prior to the grant of the option.

When does the scheme end?

Generally the scheme ends on its 10 year anniversary, unless the options have been exercised or lapsed in the meantime.

The scheme may also lapse on an disqualifying event, for example the company ceases to meet the trading activity requirements, or the employee leaves their employment.

Whilst there are certain guidelines to be met, the scheme can be very flexible in this regard and can be tailored to your requirements. Some employers even allow the option to fall to be unapproved if the EMI conditions do not continue to be met.

This sounds great! How do I set up an EMI scheme?

Initially we will have a conversation with you to ensure this is the right choice for your company, all qualifying conditions are met, and to give you an idea of costs based on what you want from the scheme.

Depending on our conversations, we will then determine whether an HMRC advance assurance is recommended.

We would then look to prepare a share valuation for HMRC’s approval, together with associated forms. This provides a level of comfort that you and the employees know the tax implications of providing this benefit to the employee(s) upfront. Once HMRC reply, we usually have 90 days to grant the option to the employee.

We can work with you and your solicitor to draw up the option agreements (and can recommend someone too if you do not have one already). Should new articles or a shareholders agreement be required, these can also be drafted at this time.

We can assist you in informing your employees and provide some guideline documentation for them. Whilst we cannot give them personal tax advice, we can give an indication on what they might receive on a sale (for example), or what the tax implications might be if the exercise price is less than the market value of the shares at grant.

Following the grant of the options, the scheme will need to be registered and HMRC notified of the options within 92 days. This is via an online form which we can assist with.

To maintain the qualifying status of the scheme, an annual return must also be submitted by 6 April following the end of the tax year. This reports any in-year events such as lapsed options, employees leaving, or exercising options. This is a process with which we can assist.

Are there any disadvantages of an EMI scheme?

As illustrated above, there are many benefits of an EMI scheme – however some of these could also be viewed as a negative.  For example, the tax advantaged status of the scheme is one of the main benefits of the arrangement, however this also means there are various conditions that need to be met to maintain the tax advantaged status. Either the company, or the employee could disqualify the scheme which limits the companies and individuals this is available to.

The scheme also expires after 10 years which, for ‘exit only’ options, can seem achievable at grant, but circumstances can change which mean this is no longer feasible. In particular, Covid delayed the growth and acquisition plans of many companies. 

It is essential to carefully consider your future intentions for the company and the agreement terms when the option is granted as the option cannot be altered. We can guide you through this process and offer tailored made suggestions and solutions you may not have considered previously.