Introduction
When the EMI scheme was introduced by the Finance Act 2000, the general reaction was that it was too good to be true. Since then, the availability of the scheme has widened and the popularity has continued and grown. We at CRM have set up a number of these schemes for our clients.
The basis of any share option scheme is that employees are given options to buy shares at some pre-defined point in the future, but at a price set at today’s value (in most cases). Therefore, when the allotted time or event occurs, if the share value has risen, then the employee stands to gain by purchasing these shares at less than the current market value. In the case of a Small or Medium sized business where the shares are not traded on the stock market, these options would most commonly be exercised on a takeover (where a cash purchaser is in the picture), or as part of the owners exit planning to pass the company on to incumbent management in a tax-efficient manner.
The freedom that is open to companies is remarkable when compared to other share schemes with favourable tax status. They can provide the kind of incentives which will fit their needs and ensure that they can recruit and/or retain key members of staff by giving them a direct interest in the equity value of the company, whilst the owners retain all voting rights until options are exercised. These schemes are so good that despite the availability of alternatives, many smaller employers also use them for the whole of their workforce rather than just the original idea that the government had suggested of benefiting the most critical members of staff.
Qualification
The first hurdle to overcome is the requirement that a company must qualify in order to operate a scheme. In reality, smaller companies will almost always qualify provided that they meet the trading requirements. In broad terms, almost all trades will qualify excluding companies that make their money from property ownership, from financial activities or leasing and from operating in certain industries for example as lawyers or accountants.
In addition, there is a limit on gross assets in the company of £30 million but in the real world, most SMEs would not expect to be anywhere near this threshold. There is now no longer any restriction on the number of employees who can benefit from EMI in any company or group.
Employee Limit
There is a limit per individual employee on options holding of £100,000. This is based on the market value of options granted, calculated as at the day on which the option is granted. Also, there is a £3 million limit for the whole company.
Finally, once an employee owns 30% of the company’s share capital or can benefit from 30% of its assets, then they will be excluded from receiving further options, although if they start at less than this figure, they could theoretically receive options over any number of shares, even the whole company. In addition, employees must broadly work full-time (at least 25 hours every week) for a group company.
The benefits to the employer
From a company point of view, there is remarkable flexibility since these schemes are selective and it is possible to write different terms for each employee who is to be included.
The employer can choose:
• The exercise price(to a degree),
• The earliest and latest dates of exercise, although there is an upper limit of 10 years from the date of grant. They can also set performance criteria, although in smaller organisations this may well prove impractical.
Normally, the only performance criterion that matters is remaining an employee of the company until the date on which the option is exercised.
It is important to note that the scheme can be drawn up so that employee’s options lapse if they leave the company, which prevents the situation of having to buy back shares from ex-employees which can occur where shares rather than options are involved.
The other major benefit for the employer is the ability to obtain corporation tax relief based on the value of shares when the option is actually exercised, without the company actually parting with the equivalent sum of money.
Employee advantages
These arrangements are relatively easy to understand, a fact that can be worth its weight in gold.
If the option is granted with an exercise price no lower than market value as at the date of grant, then there will almost never be an income tax or NIC charge arising. The only exception would be where the scheme ceased to meet qualification criteria, or the employee became a part time worker or left employment and ceased to qualify.
In these circumstances, any gain that the employee makes will be a capital gain. This has significant advantages particularly as Business Asset Taper Relief (BATR) is granted automatically on EMI shares and commences from the date on which the option is granted not from the date on which it is exercised, as in the case of all other approved and unapproved share option schemes.
This means that at the end of a two year period from the date of grant, the employee could sell his or her shares and, if they have not used up their annual exemption, make a gain of over £35,000 tax-free and pay tax at an effective rate of either 5% or 10% on the balance depending on whether they are a basic rate or higher rate taxpayer based on today’s tax rates and allowances. This is clearly a great tax break.
If the option is granted at below market value at the date of grant, then on exercise, income tax will become payable through the employee’s tax return. If the shares are readily convertible into cash (which is only the case if a ready market exists, i.e. the shares can be traded on a stock exchange, or there are arrangements in place with a ready purchaser) the tax will be collected through the PAYE system and NIC will also be due.
The amount due though is only the difference between the market value at the date of grant (or exercise if lower) and the amount paid for the shares. This is a very favourable treatment compared to an unapproved option scheme and means that the whole of the gain from the date of grant is subject to capital gains tax with all of the reliefs and favourable tax treatment that currently results from this.
Small companies
EMI schemes are generally relatively simple to set up, understand and operate. This gives them a massive advantage over the all-employee approved share schemes such as Share Incentive Plans.
In addition, simplicity means that it can be practical for a company to introduce EMI to reward a single key employee, if required, or at the other of the scale to include a whole workforce without any massive increase in difficulty.
Share valuation
As an additional benefit, it is possible to agree the market value with HM Revenue & Customs (HMRC) in advance of granting the option. This takes out any unpleasant surprises and ensures that both employer and employee know about future tax liabilities. This would be done as a matter of course by CRM in any scheme set up by us, giving you and your staff certainty of their tax position.
Keep it simple
Experience suggests that while really complex schemes appeal to some owner-managers, these are rarely a good idea as they tend to take focus away from the main goals. If you want to reward year on year short-term performance, pay bonuses, don’t restrict the options or the right to exercise. The main goal should be to keep employees at the company and interested in overall performance, nothing else.
The importance of dealing with the paperwork
The legislation requires employers to file documents within 92 days of grant. HMRC are not sympathetic to those who miss the deadline. Unless the intention is to give employees an unapproved option and tax nightmares when they exercise their options, don’t forget to file the papers. Obviously we at CRM would personally ensure that all filing requirements are met for you to avoid all the potential headaches!
Conclusion
The initial view that EMI schemes were too good to be true still holds six years later. If you are worried about keeping a key employee for a few years or would like to hold down wage costs and offer share-based incentives instead, but don’t want to lose control of the company, then this could be the perfect solution.
Do bear in mind that this article only represents an overview and you should take detailed advice before implementing an EMI or any other share or share option scheme.
