Tax efficient alternatives to EMI

The complex conditions for Enterprise Management Incentive (EMI) tax relief mean that EMI is not always an option for private companies looking to provide share incentives. We help employers work out the tax efficient alternatives to EMI for employees, directors, non-executive directors and consultants in private companies.

There are a variety of reasons why EMI options may not be a possibility including but not limited to:

• The employee/director has exceeded the EMI threshold on the number of shares that can be held;
• The employee/director holds other appointments such as non-executive directorships; and or
• The number of employees exceeds the EMI threshold; and
• The EMI subsidiary requirement is not met.

Alternatives to EMI

When looking for alternatives to EMI it is essential to ensure that directors and employees are offered share incentives that are sufficiently motivating while rewarding genuine performance. Equally, companies should avoid complex share structures and aim to offer share incentives which their workforce can readily understand.

Nil paid shares, growth shares and joint share ownership arrangements are all UK tax efficient alternatives to EMI - the "alternatives". Additionally, the alternatives provide more flexibility if the up-front cost to employees of acquiring shares would be too high compared to what they can afford and the risk they can take. These alternatives are also open to non-employees such as consultants and non-executive directors who, would not be eligible under EMI. They are also likely to be suitable for companies expecting to grow shareholder value in the future. This is because employees and directors will only benefit from the ‘upside’ in value created after they have been awarded shares.

Employers look at the alternatives in cases where the limit on the value of shares that can be award under EMI has been exceeded. Another common case is because the number of employees exceeds the EMI threshold.

Objectives behind the alternatives to EMI

The primary objective must be to put in place an effective arrangement that motivates employees to commit longer term to growing the business. Another objective is to provide tax efficiency where possible and bring profits within the capital gains tax (CGT) regime. Rates of CGT for higher rate tax payers are currently 18% to 24% (or 14% CGT from 6 April 2025 under if business asset disposal relief (BADR) applies). On the other hand the highest rate of income tax is 45% plus national insurance which will be 15% from 6 April 2025.

The type of alternative will depend upon the existing value of the shares and the tax consequences attaching to the share transaction. We guide on the issues at play.

Nil paid shares

Nil paid shares involve employees acquiring shares on terms that they do not pay for the purchase price immediately. Instead, participants agree to pay for their shares in the future. For example, on an exit event (relating to the company), when they would pay the outstanding purchase price. Awards are made by the Board to such recipients as the Board select.

The advantages for participants are the benefits of immediate share ownership, which may include dividends. By contrast, an EMI option holder won’t be eligible for dividends before exercise. The main advantage is that employees should be subject to capital gains tax (CGT) when they sell their shares, instead of income tax (and possibly NICs). If the employer were to release the employee from the liability to pay the purchase price, the amount outstanding will be taxed as remuneration.

There are also some income tax consequences of an employee holding partly paid shares. The outstanding purchase price will be treated as if it were a loan from their employer. This amount (known as a ‘notional loan’) will give rise to an annual benefit in kind charge (plus employer’s NICs) until the purchase price is paid. The benefit in kind charge will not apply to an employee if his notional loan amount, when added to any other employer provided loans to that employee, does not exceed £10,000.  The value of the shares in the private company upon which the loan will be made and the benefit in kind will apply, will be calculated on a fiscal valuation which is likely to be much less than a commercial valuation.

Growth shares

Growth shares involve the creation of a new class of share and are made at the discretion of the Board to such recipients as the Board select. The shares will have limited value when acquired. This is because growth shares will only be entitled to a proportion of the growth in shareholder value above a ‘hurdle’. This will usually be linked to the company’s performance or exit value.

The up-front cost to employees of acquiring growth shares should be relatively low. This is for the reason that the shares do not benefit from any existing value of the company, and will only be entitled to a proportion of value created above a hurdle. The main advantage of growth shares is that employees should be subject to capital gains tax (CGT) when they sell their shares.

When awarding growth shares, key factors will be the share valuation and setting the amount of the hurdle. Sometimes you will need specialist advice from a share valuation specialist.

Unapproved options

Unapproved options are the least tax efficient arrangement, but they are the most flexible as there are no statutory requirements to satisfy. This means they can be granted to any person including consultants, non-executives, employees and directors on such terms and with an exercise price as the Board determines. However, any gain made by the unapproved option holder on exercise will be subject to income tax at the highest rate and in many cases national insurance.

It is possible for the unapproved option holder and the employer to elect that the option holder pays the employer's national insurance.  Note that it is only gains on unapproved options that carry the right to pass employer's national insurance to employees/directors.

In summary, the above arrangements can deliver tax efficiencies where EMI is not a viable option. However, these arrangements require specialist input to ensure that any exposure to income tax and possibly NICs is as low as possible. As these values cannot be agreed in advance with HMRC care is required with implementation. In our experience costs can be saved if time is taken to work out what you need before the drafting starts.