Tax efficient alternatives to EMI

Enterprise Management Incentive (EMI) is not always the answer for private companies looking to incentivise their workforce. EMI may be too costly for individuals to acquire, or the individual or company may not qualify for the strict tests associated with EMI. There are other tax efficient alternatives to EMI.

It can be a daunting task for companies wanting to establish equity incentives to attract and retain their workforce. Where companies may (and often do) struggle is over the type of equity incentives to establish and what may be ‘right’ for them.

A key factor will be to ensure that individuals are offered incentives that are sufficiently motivating but at the same time reward genuine performance. Equally, companies should avoid complex structures and aim to offer incentives which participants can readily understand.

Nil paid shares, growth shares and joint share ownership arrangements are all highly UK tax efficient arrangements. They are likely to be suitable for companies expecting to grow shareholder value in the future. This is because individuals will only benefit from the ‘upside’ in value created after they have acquired their shares or ownership interests. Additionally, they are suitable if the up-front cost to employees of purchasing shares would be too much. These arrangements are also open to non-employees unlike under EMI.

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.

The advantages for participants are the benefits of immediate share ownership, which may include dividends (in contrast an 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 (BIK) charge (plus employer’s NICs) until the purchase price is paid. This BIK charge will not apply to an employee if his notional loan amount, when added to any other employer provided loans, does not exceed £10,000.

Growth shares

Growth shares involve the creation of a new class of share. 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 CGT when they sell their shares.

When awarding growth shares, key factors will be share valuation and setting the amount of the hurdle. Companies should preferably agree a valuation with a share valuer who is experienced in the valuation of employees’ shares.

Joint share ownership arrangements

Joint share ownership arrangements (JSOP) provide similar tax efficiencies to growth shares. Companies may consider JSOPs if they are not eligible for EMI, or do not want to create an extra class of shares. They are also suitable if the up-front cost to employees of purchasing shares would be too much.
A JSOP involves co-ownership of shares split between an employee and the trustee of an employee benefit trust (EBT). The employee’s interest in shares entitles them to the benefit in value of the shares above a certain level. This is typically set at market value on the acquisition date, although it may be a higher price. All other value is held by the trustee of the EBT.

Details of the interests in shares, held by the employee and EBT, will be set out in a joint ownership agreement (JOA). The JOA will also set out how employees may be able to sell their interests in shares, for example, on an exit event or on leaving employment.

Employees will either pay market value for their ownership interests in shares, or income tax (and possibly NICs) if the market value of that interest exceeds any amount paid. On vesting of the employees’ shares, which could include an exit event, the employee (or jointly with the EBT) would sell their shares. The growth on sale of the shares should be subject to CGT.

A key part of establishing JSOPs will be the valuation of the employee’s interests in shares on the acquisition date. As with growth shares, it is preferable to agree a valuation with a share valuer who is experienced in the valuation of employees’ shares.

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 with HMRC it is imperative that specialist advice is taken to minimise the tax risk for both employers and participants.