Implementing an EMI scheme
The number of employers currently providing EMI options is increasing.
EMI options granted under EMI schemes are very popular with our SME client base. EMI options if well communicated so as to be understood by employees are good motivators and provide a sense of being part of the action for employees. And, EMI schemes are relatively inexpensive to set up. The number of employers currently providing EMI options is increasing.
To help you decide if we could help you with an EMI scheme we have summarised how we went about a recent EMI case.
EMI option scheme for communications company
We designed and implemented an EMI option scheme for a communications company looking to retain two key software developers who were important in the plans to develop the business ready for a sale of the company. The software developers had previously been contractors who had come on board as directors and become part of the management team and in return had been promised shares in the business.
Business motivation behind the EMI scheme
As is usual, it took the employer some time to get around to delivering on its promise to provide shares. The employer was not sure how to proceed. We took the employer through the advantages and disadvantages of issuing shares as opposed to option. The idea of gifting shares to the directors did not appeal because of fears over how much tax the directors would face as the profits were growing. There was also a worry that the directors could leave holding shares. The business motivation was to prepare for an exit.
Reason for our recommendation
We recommended an EMI scheme because the EMI options can be drafted so as to only become of value if there was an exit and the director was employed at the point of exit. Exit only EMI options do not generate any tax liability until the exit or sale of the business, whereupon the employees or directors will be in receipt of funds to settle the tax bill. This is one of the biggest advantages EMI options hold over the alternative of awarding shares.
Tax position for the directors
The employer was keen to ensure that the directors were only liable to capital gains tax on sale of the shares. This objective was achieved by us agreeing with HMRC the “tax market value of the shares” on the date of award and fixing the exercise price to that level. In order to agree the position with HMRC, we analysed the profits and future plans for the business. Using our review we presented an argument designed to encourage HMRC to agree the value of the shares for option purposes was not as high as the price that would be paid by say an investor. We have undertaken many negotiations with HMRC and knew which points to highlight.
If the exercise price was below the tax market value of the shares on the date of award, there would have been an income tax and NI charge on exercise which averages out at tax of over 50%. But, even paying the income tax left the bulk of the gain chargeable to capital gains tax at 10%.
Tax reporting for the employer
There are tax reporting obligations and deadlines for employers – we made sure the employer knew what to do.
Similarity of qualifying trading conditions between EMI and SEIS
The company had already qualified under SEIS and issued shares to investors. We explained that the qualifying trading conditions for SEIS were very similar for EMI options.
Intellectual property assignment
When we looked into matters we discovered that some of the software developed before joining the company had not been properly assigned to the company. This would have caused problems when the due diligence for sale was dealt with, as there was a risk that the developers would claim ownership. We were able to secure agreement to assign the software at the same time as the EMI options were granted.
The employer wanted to make sure that the directors understood the value of the EMI options so as to maximise the incentive. We put together a presentation and met with the directors to answer any questions.
The company was sold and the EMI option holders became millionaires.
We have withheld names for reasons of confidentiality. However, we are happy to provide references.
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