Agreeing the value of shares under EMI option on grant with HMRC - how it works and why it matters.

We recommend considering the valuation of EMI shares at the planning stage. Agreeing a suitable market value with HMRC before granting options can help optimise the tax position for employees and give them greater certainty about their potential returns. We can assist with valuations and other key decisions involved in implementing and managing an EMI scheme.

EMI options are not simply standard arrangements. The commercial terms, share rights and tax implications will vary between companies. We work with clients to develop arrangements tailored to their circumstances, drawing on our experience of the EMI rules and common pitfalls.

Why market value is relevant for EMI options

The market value of shares at the date an EMI option is granted is relevant to several aspects of the EMI tax regime, particularly:

• Whether the options satisfy the individual and company limits for EMI.
• Whether income tax and, in some circumstances, National Insurance contributions may be payable when the options are exercised.

HMRC distinguishes between actual market value (AMV) and unrestricted market value (UMV). These are different measures used for different purposes under the EMI rules. This insight focuses on the importance of establishing the appropriate value when options are granted.

Market value impacts on whether the options qualify for EMI

Under the EMI rules, an employee generally cannot hold EMI options with an aggregate UMV exceeding £250,000 at grant. The company must also satisfy the relevant limit on the total UMV of shares under EMI options, currently £3 million.

The relevant values are assessed at grant. A subsequent increase in the shares’ value does not, by itself, mean that the options cease to qualify, although other changes or failures to meet the EMI requirements can affect their tax treatment.

Can the EMI options be exercised tax free?

The tax treatment on exercise depends on factors including the exercise price compared with the AMV at grant and whether the EMI requirements have been met throughout the relevant period.

Agreeing the share valuation with HMRC before granting the options can provide greater certainty. It also helps employees understand the potential tax treatment and estimate their returns.

Example of how market value works

Imagine a company grants an employee options over 200 shares, with an exercise price of £2 per share. The shares are eventually sold on an exit for £50 each.

If no valuation is agreed with HMRC

Suppose the company uses £10 per share as the AMV at grant, based on a previous investment round, without obtaining HMRC agreement. If the exercise price is below the AMV at grant, the difference may be subject to income tax on exercise. Depending on the circumstances, National Insurance contributions may also arise. Any subsequent increase in value may qualify for capital gains tax treatment.

If the valuation is agreed with HMRC before grant

Suppose HMRC agrees an AMV of £2 per share and the option is granted with an exercise price of £2. If the EMI conditions are satisfied, there will generally be no income tax or National Insurance liability on exercise. The increase in value may instead be subject to capital gains tax on sale.

The actual outcome will depend on the agreed valuation, exercise price and whether the relevant EMI conditions are met. This is why we recommend addressing valuation before options are granted: agreeing a value retrospectively can be more difficult, particularly once the company has grown in value.

How HMRC deals with EMI market valuation

For tax purposes, market value is based on the price the shares might reasonably be expected to fetch in an open-market sale. This does not necessarily match the price paid by investors or the amount a buyer might pay for the business as a whole.

HMRC considers the company’s circumstances and the rights attached to the shares. For smaller private companies, relevant information may include:

• Historical and anticipated profits.
• Management accounts and other financial information.
• Major contracts and key personnel.
• Offers to acquire the business.
• Previous share transactions and investment rounds.

The valuation is submitted to HMRC’s specialist share valuation team. HMRC undertakes an initial risk assessment, and some valuations may receive limited, without-prejudice acceptance while others are examined in greater detail.

Other factors HMRC considers when valuing EMI shares

HMRC may take account of:

• The frequency and terms of previous share transactions.
• Differences between share classes and any preferential rights.
• Minority shareholdings and the rights attached to them.
• Restrictions on the business or its activities.
• Share transfer restrictions, pre-emption rights and forfeiture provisions.

Valuation requires commercial judgement as well as financial analysis. The appropriate approach depends on the company’s circumstances, and further discussions with HMRC may be necessary.

How Gannons can help

Gannons assists companies at different stages of growth with EMI implementation, share valuations and replacement options where share values have fallen since the original grant. Our experience in agreeing valuations with HMRC and drafting the associated legal documents helps streamline the process and reduce the need for additional specialists.

Contact us on 020 7438 1060 to discuss your EMI options and valuation requirements.