EMI – Enterprise Management Incentive Scheme
A small company trying to grow will want talented individuals to facilitate this growth. They might wish to retain the valuable employees they already have or attract a high calibre of new employees. To do this, they could consider offering them share options through a scheme that minimises the tax liabilities. One such scheme is the enterprise management incentive (EMI).
By offering employees share options, the company is tying its success with the personal benefit of the employee. To further sweeten the deal, offering the shares under an EMI is highly tax-advantageous for the employee. Ultimately, the objective of the EMI scheme is to improve a company’s performance and therefore its value.
Qualifying for the EMI scheme
Before an EMI may be utilised, the company must first ensure that both it and the target employee qualify for the scheme. First, the options must be issued purely for commercial reasons whereby the employee retained or recruited is done so in an attempt to grow the business. The legislation is very clear in stating that the main purpose (or not even one of the main purposes) cannot be the avoidance of tax.
The criteria for the company includes the following:
- assets of no greater than £30 million
- fewer than 250 employees
- the company must operate on a commercial basis with the view to generate profit
- it cannot operate in any excluded activity
- it may offer no more than £250,000 of share value per employee and £3 million for the whole company.
The criteria for the employee includes the following:
- they must work, on average, 25 hours or more per week for the company or for at least 75% of their working time to be committed to the company if
- they must not already own an interest of 30% or more in the company or a company within its group
The tax implications of an EMI
For the employee
As with an unapproved share option, no charge to income tax arises on the grant of an option through an EMI. Where they differ is upon exercise of the option.
Under an unapproved share option, the income tax due on exercising the option is the difference in the amount paid for the share and its market value at the date of exercising. For example, imagine that an employee holds options over shares with a market value of £50,000. The employee only pays £10,000 for the shares. Chargeable income of £40,000 will be attributed to the employee.
Under an EMI, the income tax due on exercising the option is instead the difference in the amount paid to exercise the shares and the market value of shares at the date on which the option was granted. Take the previous example with the extra information that, at the date the option was granted, the shares had a market value £10,000. The employee, like previously, pays £10,000 for the shares that had a market value of £50,000 at the date of exercise. This time, no charge to income tax is due.
The effect of an EMI scheme is to exempt the individual from any income tax that would occur due to the growth in value of the shares. When the employee eventually sells their shares, they will be subject to capital gains tax (CGT).
The usual calculations for CGT apply and the disposal may qualify for business asset disposal relief (BADR). Under an EMI, the normal conditions for BADR are the same except that:
- it is not required that the shareholding be at least 5% in voting power and share capital
- the grant of the option (rather than the actual shares) must have been held for at least two years before they are sold
If the above is satisfied, the CGT will be charged at 10% up to the lifetime allowance of £1 million.
For the company
As is required in the legislation, the avoidance of tax should not be a main reason for the scheme and it is essential that it is done on a commercial basis. Regardless, there is still a benefit to the employer for using an EMI.
The company will get a deduction to corporation tax if shares are acquired by an employee under an EMI option. The deduction available is the difference between the market value of the shares when they are acquired and the amount actually paid for them. The effect of this is to negate some of the “loss” a company has made by selling its shares under market value.
Any company wishing to utilise an EMI should be aware of scenarios that would disallow the tax reliefs granted by the scheme. Perhaps the most likely examples of disqualifying events includes the following:
- an employee fails to meet their working time requirements during the tax year
- an employee ceases employment with the company
- the company does not continue to meet qualifying trading activities or is bought out by another company
- an alteration is made in the share capital which affects the value of the shares and it is not done for made for commercial reasons or its main, or one of its main purposes, is to increase the market value of the shares.
The above list is not exhaustive but does provide some of the most common scenarios. Even if a disqualifying event happens, tax relief can still be retained if the employee exercises any options within 90 days of the event. Past such time the reliefs are restricted.
EMIs are clearly very tax advantageous for both parties involved. Tying the value of the company to the employee’s personal wealth ensures that the employee is properly motivated to perform at their best. In addition, it also receives a deduction to corporation tax. For the employee, they are able to exercise their options free of a charge to income tax and can even go on to sell their shares under slightly relaxed BADR rules.
However, it is vital that the conditions are satisfied and that the proper administration is adhered to – failure to do so may result in penalties. In addition, an EMI may not always be feasible due to the criteria and alternatives might need to be considered. It is important that planning is undertaken by a specialist that can look at the company as a whole and advise on a strategy that best suits its objectives.
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