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Enterprise management incentive schemes and EMI options are versatile and tax efficient. We have set out below some of the key advantages to EMI schemes and EMI options with a summary of the taxation benefits of EMI schemes.
Areas covered include:
Background
Enterprise management incentive EMI schemes can be granted to any employee or director who satisfies the EMI requirements - see below. One of the big advantages of enterprise management incentive schemes is that they are discretionary and do not need to be offered to employees and or directors on equal terms or at all. The other major advantage is that EMI options are very tax efficient not only for employees but also for their employers who can claim corporation tax relief.
There is considerable choice and flexibility given to employers to determine how they will operate enterprise management incentive share options (EMI). EMI options are far more flexible than other HMRC tax approved share options such as Sharesave (SAYE) schemes or share investment plans (SIPS).
Some of the factors to consider include:
Each grant of an EMI option must be covered by a written agreement between the company and the employee/director specifying:
For a variety of reasons it is usually necessary to value the shares in an unquoted company and agree the valuation with HMRC Shares Valuation Division. The main circumstances in which a valuation is required include:
It is good practice to agree in advance of the grant of any EMI option over shares in an unquoted company the tax market value of the shares. The tax market value of the unquoted shares on grant is required:
In cases where an income tax charge arises upon exercise of the option and there is no immediate market for the shares, (i.e. there has been no disposal), it will be necessary to agree with HMRC the market value of the shares on exercise of an EMI option under an EMI scheme. The market value of the unquoted shares is required, in order to calculate the charge to income tax, (and in most cases national insurance), arising if the option does not qualify for EMI tax relief throughout its life.
Share valuations can be prepared using a variety of valuation methods which will vary depending upon the nature of the business and the stage of the company's development. Factors to consider include:
It is important to adopt the correct valuation method and agree a fair value with HMRC since this forms the basis of tax charges incurred by employees.
In practice, although employees are personally required to report gains on unquoted shares made on exercise or disposal on their personal tax returns, employers usually undertake the valuation process on their behalf.
Enterprise management incentive share options EMI are designed to be tax efficient for both the employees and the employer.
For employees, the biggest tax incentive is the fact that all of the growth in value on the shares awarded under an EMI option will not be treated as income for tax purposes, but instead will be subject to the more tax advantageous capital gains tax (CGT) regime.
For employers, there are corporation tax savings which can be substantial if the shares grow in value. In addition, companies providing EMI options to their employees can deduct the cost of setting up and administering the EMI scheme when computing their corporation tax profits.
If the option is unapproved for taxation purposes (referred to as an unapproved option), the gain arising upon exercise of an unapproved option awarded under an unapproved plan will be subject to income tax and in most cases national insurance. The gain is the difference between the market value of the shares on exercise less the exercise price paid by the employee/director to acquire the shares.
In practice, many employees/directors dispose of shares acquired upon exercise of both EMI options and unapproved options immediately. If the options are exercised in conjunction with the sale of the company, exercise will take place immediately before disposal. In this scenario, there is no capital gain arising upon disposal, as all of the gain will have been assessed to income tax (and in most cases national insurance) on exercise and hence none of the advantages of the capital gains tax regime apply.
Certain events will mean that the option does not qualify in full for enterprise management incentive share option EMI tax relief - a "disqualifying event". Disqualifying events include (but are not limited to):
Disqualifying events can result in a loss of tax relief on any increase in share values from the point of the disqualifying event onwards. HMRC do however allow a period of 40 days grace, before tax relief is removed.
The company will need to review its articles of association and authorised share capital limits before implementing an EMI scheme. Consideration must be given to how the company can make sure EMI option holders will not hamper a sale of the company or other corporate activity. There are various ways in which the company can protect itself but this often requires amendments to the articles and or a shareholders agreement so that EMI scheme participants are bound to sell their shares when the majority of shareholders want to sell.
Enterprise management incentive schemes and EMI options can be effective and tax efficient. EMI schemes are known as the currency of choice. However, companies must ensure that all the requirements are met and be aware of the administration involved, including share valuation and the disqualifying events which would lead to the loss of EMI tax relief.
This paper is designed to provide a summary of the issues addressed. Therefore, it is not intended as a detailed commentary on the relevant law and any comments made should not be acted upon without first taking specific legal advice.