Employees may be one of the most significant assets of your business. One approach that is often used to recruit and retain key staff is the grant of enterprise management incentives options (EMI Option) which is a type of employee share option that enjoys favourable tax treatment.
There are a number of requirements to satisfy for the grant of EMI Options and these include:-
- The Company must qualify to grant EMI Options. It must be an independent trading company which means it must not be a 51% subsidiary or under the control of another company.
It must have:
- gross assets of no more than £30 million;
- fewer than the equivalent of 250 full-time employees
- a UK permanent establishment (or if not but it is a parent company then a member of its group must exist to carry on a qualifying trade and either do so or be preparing to do so and have a UK permanent establishment),
and it must carry on a qualifying trading activity.
Any subsidiaries must be qualifying subsidiaries which means that they must be at least 51% subsidiaries of the Company and they must not be under the control of any other person other than the Company and another of its subsidiaries and they must not be subject to any arrangements under which these conditions would cease to be met.
It is possible to seek clearance from HMRC to confirm that a Company does qualify to grant EMI Options if there is uncertainty.
- The EMI option must take the form of a written agreement between the option holder and the grantor which states the main terms of the option, including how and when it may be exercised and the number of shares over which the EMI Option is granted.
The agreement must also contain details of any relevant restrictions which apply to the shares which could make them restricted securities. An employment-related security is a restricted security if its market value is reduced because of any restriction that falls within one of the following three categories:
- Forfeiture in certain circumstances.
- Limitation on a right over, or conferred by, the securities.
- Disadvantage suffered by employee, holder or connected person.
An example of this might be a provision in a Company’s articles providing that employees must transfer their shares if they leave employment for a payment less than the unrestricted market value.
An EMI Option can be granted by way of standalone agreement which is commonly used if only one or two members of staff are receiving options or if more employees are to receive options then the options are usually granted by way of plan rules and individual short form option agreements.
- The shares which are the subject of the EMI Option must be fully paid, ordinary, non-redeemable shares. The shares can be new issue shares or shares transferred from an existing shareholder, including an employee benefit trust. It is possible to have a separate class of employee shares for the purpose of the EMI Options with reduced rights compared to the standard ordinary share capital in respect of voting and the right to participate in distributions. The voting rights of the shares subject to EMI Option can be less that those attached to other ordinary shares but must confer on the holders as a minimum the right to vote on any proposals to change the rights of the shares of that class. A point to consider is whether if the shares subject to EMI Option have reduced rights and are of little relative value they will act as an effective incentive.
- EMI Options can only be granted to employees and to be eligible to be granted an EMI Option, an employee must work for the Company for at least 25 hours per week, or if less, 75% of their working time. An employee cannot be granted EMI Options if he (or his associates) have a material interest in the Company which will grant the EMI Option or any of its subsidiaries. A material interest means beneficial ownership or control of more than 30% of the shares or entitlement to 30% or more of the assets on a winding up or distribution. Non-employee directors and consultants cannot be granted EMI Options.
- The EMI Option must be capable of being exercised within 10 years. EMI Options usually lapse after 10 years as EMI tax relief is not available after that time.
The exercise price of an EMI option can be set at any level. Setting an exercise price that is less than market value at grant has consequences for the tax treatment of the EMI option on exercise. Please see below.
It is usual but not obligatory to agree the value of the shares to be subject to an EMI Option with HMRC prior to grant of the options. There are a number of reasons for this:-
- it enables the Company to check the proposed grant will not exceed the individual and overall limits on the grant of EMI options. Please see below.
- if a valuation is sought some time after grant, it may be difficult to get a valuation agreed, particularly if the Company’s circumstances have altered since the options were granted.
- it also gives the option holder and the Company some certainty regarding the likely tax treatment of the options.
Exercise of EMI Option
The EMI legislation requires that EMI options must be capable of being exercised within ten years of the date of grant, and options can only be exercised within a period of 12 months after the option holder’s death. Otherwise EMI Options are quite flexible which means that they can be used for exit-only arrangements so that an option can only be exercised on an exit event, such as a share sale or listing of shares, as well as for arrangements where options are exercisable at the end of a vesting period and/or subject to the satisfaction of certain performance conditions.
Lapse of EMI Options
Save as mentioned above, there are no restrictions on when EMI options can be exercised or will lapse. However, it is usually best to specify clearly when options will lapse. Often, the EMI option agreement will provide that options will lapse on leaving employment, although early or partial exercise may be permitted in certain circumstances. The EMI option agreement will also usually provide that options lapse if the option holder becomes bankrupt, or tries to transfer the options or use them as security.
For employees there is a limit, presently £250,000, on the market value (as at the respective dates of grant of the relevant options and ignoring certain restrictions) of shares that may be acquired by an employee in respect of employment with a company or group of companies under all EMI options held at any time that remain capable of exercise and under all EMI options held at any time plus those granted within the preceding three years to the extent that they have been exercised or have lapsed. It may however with planning be possible to grant options to an individual employee worth more that £250,000 in a period of three years.
For companies there is a limit of £3 million worth of shares (valued at the relevant dates of grant and ignoring certain restrictions over the shares) which can be subject to unexercised EMI Options at any one time. There is no limit on the number of employees who can hold EMI Options.
Certain events that happen after EMI options are granted are “disqualifying events”. If a disqualifying event happens, and options are exercised within 90 days, existing EMI tax reliefs are preserved. If options are not exercised within 90 days, income tax will be due on the difference between the market value at the date of the disqualifying event and the market value at exercise.
There are a number of disqualifying events some of which relate to the Company and some to the employee, such as
- The Company whose shares are under option becoming a subsidiary of, or under the control of, another company However, if the EMI option is exchanged for a replacement EMI option granted by a new parent company, the change of control will not be a disqualifying event.
- The Company ceasing to meet the trading activities requirements This includes the situation where the company originally met the trading activities requirement because it was preparing to carry on a qualifying trade when the option was granted. There is a disqualifying event if it discontinues those preparations, or if it does not commence the qualifying trade within two years of the grant date of the EMI options.
- The employee ceasing to satisfy the working time requirements.
In brief, if the option remains a qualifying option and no disqualifying event has taken place before exercise, the tax treatment for an employee holding an EMI option is as follows:-
- On the grant of an EMI Option, there is no income tax liability.
- On exercise of the EMI Option, there is no income tax liability if the exercise price is at least equal to the market value of the shares subject to the EMI Option at the date of grant. If the exercise price is less than the market value of the shares subject to the EMI Option at the date of grant, then income tax is due on the difference between the exercise price and the market value at grant.
- On disposal of shares acquired following exercise of the Option, capital gains tax (CGT) may be payable on any gain over the market value of the shares subject to the EMI Option at the date of grant. Shares acquired on the exercise of the EMI Option may qualify for entrepreneurs’ relief, provided conditions are met, with the holding period of the option counting towards the 12 month holding period for the shares required for the relief to apply.
- Liability for National Insurance Contributions follows the income tax treatment as a rule. If therefore there is no income tax liability there is usually no liability for national Insurance Contributions.
As regards the Company granting an EMI Option, a corporation tax deduction may be available when an EMI option is exercised (under Part 12 of the Corporation Tax Act 2009).
Relief is given in the accounting year in which an EMI Option is exercised and should be claimed by the Company employing the Option Holder which may be different to the Company which granted the EMI Option. The deduction is equal to the gain the employee makes.
Notification to HMRC
The grant of EMI Options must be notified to HMRC within 92 days of the date of grant of the options.
Notification is made using the ERS online service and the Company has to register the scheme first with HMRC to do so. Failure to do so results in loss of the EMI tax status
This article does not constitute legal or tax/accounting advice. Specific legal and tax/accounting advice should be taken before acting on any of the issues covered.