Our tax advisory team can help you implementing EMI schemes in your company.
Outlined below is a brief description of the EMI scheme, together with how the scheme works and the implications for those employees who hold EMI options.
What is it?
EMI is an HMRC approved share option scheme. It is an opportunity for employees to acquire shares tax efficiently with no immediate up-front cost.
If shares grow in value after the options are exercised, employees have an opportunity to acquire shares at a favourable price.
The profits made on disposal can be taxed at rates as low as 10%.
The employees are granted options to acquire shares at a later date.
The price the employee will pay to acquire the shares is agreed when the options are granted. The exercise price is usually set at equal to or above the market value of the shares when the options are granted. This value can be heavily discounted and should be agreed with HRMC at the time options are granted.
EMI options are limited to shares with a value of £250,000, measured at the time the options are granted.
The options are commonly exercised just prior to sale of the company and the shares acquired are then sold to the new owner. Alternatively, the scheme can allow option-holders to exercise their options and become shareholders before any sale of the company.
When the employees may sell their shares, the profit made (being the difference between the agreed exercise price and the sale price) is taxed under Capital Gains Tax, which gives a 10% rate with Entrepreneur’s Relief.
With EMI options, any profit on sale of the shares acquired escapes Income Tax and National Insurance and is taxed at the lower Capital Gains Tax rate (assuming the exercise price was an HMRC agreed market value price).
Shares acquired under an EMI scheme can attract Entrepreneur’s Relief (10% tax rate) on holdings of less than the usual shareholding requirement of 5% of the shares provided the options were granted at least 12 months before the shares are sold.
Contrast this with a non-EMI employee benefit or bonus, which is taxed at income tax rates of 40% or 45% and is also subject to employee’s and employer’s NIC.
Summary of Option rules
This summary is intended to provide an outline of the key features of EMI schemes.
The options are exercisable at any time up to ten years from the date of the grant of the option, depending on the individual rules the company chooses to adopt. On a takeover, the options can be exercised prior to sale, or alternatively, the options can be rolled over into equivalent options in the new owner of the business (at both the option holder’s and the new owner’s discretion).
The exercise of the options can be subject to the successful meeting of performance criteria as set out by the Board of Directors.
In general, on exercise of the Options no liability to income tax or NIC would arise provided the option price is not set at less than the market value of the shares at the date of grant of the option.
The option holder retains full entitlement to exercise his or her option whilst he or she remains an employee, unless the options lapse (see below). Employees must work for a minimum of 25 hours a week or, if less, 75% of their available working time, to qualify.
The options will lapse at the earliest of:
- the tenth anniversary of the grant – this is required in order to obtain HM Revenue & Customs approval;
- the option holder ceasing to be an employee (except at the discretion of the board);
- the option holder being adjudicated bankrupt; or
- the option holder not meeting any set performance criteria within the specified timeframe; or
- in the event of a takeover or liquidation of the business (see above).
Most employment benefits or bonuses are subject to income tax at 40% or 45% and employer’s and employee’s NIC.
EMI options are designed to be taxed under capital gains tax (“CGT”), which is at a rate of 10% if the share sale qualifies for entrepreneurs’ relief.
Entrepreneurs’ relief allows the first £10m of qualifying gains to be charged to CGT at an effective rate of 10%. Claims for relief can be made on more than one occasion, up to a lifetime total of £10m of qualifying gains.
Shareholders may qualify for entrepreneurs’ relief provided that
- they are an officer or employee of the company, for a period of at least 12 months ending with the date of disposal;
- the shares are held in a trading company or holding company of a trading group; and
- in general, for 12 months they have held at least 5% of the ordinary share capital of the company which enables the individual to exercise at least 5% of the voting rights in that company;
- for holders of shares acquired following exercise of EMI options the above 5% shareholding test does not need to be met. The options must have been granted at least 12 months before the shares are sold.
Disposals of shares which do not qualify for entrepreneurs’ relief will be subject to the 28% (or 18% for basic rate taxpayers) rate of CGT, irrespective of the time for which the shares have been held.
When the EMI options are exercised, the employing company can usually obtain a corporation tax deduction, which is based on the difference between the price paid for the shares by the employees and the market value of those shares on the date they are acquired by the employees, leading to potentially significant tax savings for the company.
It should be noted that the special tax status of EMI options will be lost upon the occurrence of a disqualifying event. Disqualifying events include, but are not restricted to;
- the company ceases to be independent e.g. becomes a 51% subsidiary of another company;
- the company no longer meets the trading activities requirement;
- the employee is no longer eligible – ceases to be an employee or becomes part-time;
- material changes are made to the terms of the option;
- certain alterations to the share capital of the company;
- a conversion of shares under option; or
- grant of an option that takes the option holder over the £250,000 limit.
Employees retain tax advantages for 90 days after a disqualifying event and the scheme rules can be designed to allow employees to exercise their options within the 90-day window, if required.
If you have questions regarding EMI schemes and how to implement them in your company, please do not hesitate to contact our Tax Director Holly Bedford on 01491579740.