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Taxation

The Enterprise Management Incentive (EMI) scheme

The Enterprise Management Incentive (EMI) scheme
Nicole Patel

By Nicole Patel

15 May 2023

The Enterprise Management Incentive (EMI) scheme is an approved employee share scheme specifically designed for trading companies with growth potential.

The enterprise management incentive allows employers to grant share options to key employees tax efficiently, as a reward for their efforts within the business and/or to retain and incentivise key employees long-term. They provide employers and employees with significant tax benefits and are much more flexible than other tax favoured share arrangements.

A large number of EMI schemes are ‘exit-based’ with the share options being exercisable on a sale or flotation of the company. Most owner-managers prefer this type of arrangement since the option holders do not become shareholders until shortly before the sale of the company. This ‘rewards’ the employee option holders with a share of the sale proceeds (taxed at beneficial capital gains tax rates).

What is an Enterprise Management Incentive Scheme?

The Enterprise Management Incentive (EMI) Scheme is a tax advantaged employee share option scheme which is geared towards smaller entrepreneurial businesses. It provides your employees the opportunity to grant share options up to the value of £250,000 in a three year period. It can be an attractive way to incentivise your employees towards a view of future capital growth and performance targets.

What are the key advantages of Enterprise Management Incentive schemes?

The main advantage of EMI schemes is that employees can acquire shares at a later date at the market value at the grant date (usually at a significant discount), and exercise without an income tax or National Insurance charge. On a subsequent sale, the profit will be taxed under the capital gains regime, potentially at 10% with Business Asset Disposal Relief (BADR), while it remains in existence. This is so long as the shares are not sold within 24 months of the option grant and all other requirements relating to BADR (other than the need to hold shares representing a 5% interest in the company) are met.

Other key advantages of an enterprise management incentive scheme include:

  • The company can deduct the cost of setting up and running an EMI scheme and to deduct the gain on the shares between the grant and the date of exercise from their income for corporation tax purposes;
  • The company can choose exactly who receives the option. However, they cannot be distributed to employees who have 30% or more of the company’s shares;
  • The options can be granted conditionally, subject to performance criteria;
  • The company can decide the exercise price and the option period;
  • The market value of the shares can be agreed in advance of the option grant with HM Revenue and Customs (HMRC);
  • Voting restrictions can be placed over the shares subject to EMI options to protect the owner-managers’ position.

Enterprise Management Incentive schemes in practice

Employee A is granted an EMI option to acquire 2% of the shares in their employer’s company at a market value of £5,000 which is the exercise price. Four years later, A exercised the option when the shares had a market value of £15,000. No tax is paid when the option is granted, nor is there any tax when the share option is exercised.

At a later date, A eventually sells the shares for £20,000. At this point capital gains tax is payable on the gain which is the difference between the proceeds from sale and the market value when the share options were exercised. In this case, a gain of £15,000 has arisen (£20,000 from sale minus the £5,000 from exercise). Assuming no reliefs and A is a basic rate taxpayer, tax would be 10% of the gain resulting in £1,500 in tax.

If the same scenario were to occur outside a tax-advantaged EMI scheme, income tax of 20% (at higher rates to capital gains tax) would be payable upon exercise on the £10,000 (market value when exercised of £15,000 minus the exercise price of £5,000), resulting in £2,000 of income tax payable. Upon sale of the shares, capital gains tax (of 10%) is paid on the £5,000 which is the growth in value since share acquisition, resulting in tax of £500. This would result in total tax paid being £1,000 higher than the EMI scheme of which £2,000 is paid at an earlier date.

Which companies qualify?

There are a number of legal requirements that companies must satisfy in order for their share options to qualify as EMIs, including:

  • The company must carry on a “qualifying trade” in the UK. If the option is for a group of companies, at least one company in the group must carry on such a trade;
  • The company (or group of companies) must not have gross assets exceeding £30 million at the time the share option is granted;
  • The company whose shares are used may be listed or unlisted on a stock exchange, but it must be an independent company. In the case of a group of companies, the options must be over shares in the parent company to meet the EMI requirements;
  • The company (or group of companies) must have fewer than 250 full-time employees at the time the share option is granted;
  • All employees must work at least 25 hours a week or 75% of their total working time for the company.

Share option value limits

At the time of the grant an employee may not hold unexercised EMI options worth more than £250,000. The company may issue up to a total of £3 million unexercised share options to all its employees. The options must be exercised within 10 years.

EMI set-up process

  1. Establish elegibility: Check company meets above criteria for EMI
  2. Create Scheme: Outline vesting schedule, exit-based or exercisable
  3. File for Valuation: Your business must file with HMRC for a valuation
  4. Authorise Share pool: Authorise the share pool and receive approval from shareholders
  5. Grant EMI Options: Options may be granted to the employees from share pool
  6. Register with HMRC: Register your EMI scheme options with HMRC in 92 days

When is the best time to grant EMI shares?

The obvious answer is when share prices are low, that is an opportunistic time to grant options, because of the possibility of greater gains for employees in the future, when the share price rises.

For owner managed companies thinking about granting EMI share options, there are points to consider regarding the timing and valuation.

Share dilution

The issue of new shares on exercise of share options, will result in dilution for existing shareholders. Granting EMI options at an early stage in the company’s development should result in larger gains for employees, and lower dilution for founding shareholders

Looking for investment

Consider granting EMI options before any definite negotiations are entered into. Even if you haven’t had the investment yet you may need to inform HMRC. If you are discussing the value of the company with a third party, you should disclose this when agreeing the valuation with HMRC. Those discussions may result in a higher valuation in the shares, so it is advisable to grant options earlier rather than later to make the most of a pre-investment share value.

Exit

If “exit only” EMI options are being granted, get the options in place as soon as you can and well before you are commencing discussions with potential buyers. This is because:

  • If Heads of Terms have been entered into with another business wanting to buy your company, your company may not qualify for EMI as this could be regarded as “arrangements”, whereby your company could cease to be independent;
  • As mentioned previously if the company is sold within two years of the EMI options being granted, the EMI option share will not qualify for the expected capital gains at 10%;
  • The nearer to the sale of the business, the higher the valuation is likely to apply to the shares, and the smaller the potential gains for the option holder.

An important part of the success of your EMI scheme is the value of your company’s shares. As the company owner/manager, you will have the knowledge of how your company is performing financially and how it is likely to perform in the near term. You also know whether you require outside investment, or you want to sell, and the value that you want. From this you will be able to gauge the optimum timing for the grant of EMI options for your company.

At Gerald Edelman, we are able to assist with the entire process, from the design of the scheme, undertaking the valuation and drafting scheme rules as required, so please do not hesitate to contact us should you be considering share schemes. For more information please email hello@geraldedelman.com.