Enterprise Management Incentives
An Enterprise Management Incentive (EMI) is a scheme provided by employers to reward key staff within the business. It is only available to smaller companies.
A company is able to grant options to the employees to allow them to acquire its shares over a specific period and if certain conditions (detailed below) are met:
No tax is payable on the exercise of the options provided there was no discount on the grant.
No income tax payable if there is a change in value of the shares between grant and exercise.
CGT is payable on the sale of the shares based on the difference between the proceeds and market value at date of grant.
On disposal of the shares, there is entrepreneur’s relief available. The conditions are slightly different whereby, there is no minimum holding requirement to qualify for relief. The 12-month holding period includes the option holding too.
In order to qualify for the EMI status, the correct procedure must be followed. The scheme must be set up within the terms of the legislation and HMRC must be notified within 92 days of granting an option.
A company can be quoted or unquoted.
Be independent (not a 51% subsidiary of another company or controlled by another company or a company and persons connected to it).
Have gross assets of less than £30 million.
Have fewer than 250 full-time employees.
Have only qualifying subsidiaries: a company must hold more than 50% of the ordinary share capital of any companies it acts with; so joint ventures can sometimes be problematic.
Satisfy the qualifying trade test: must exist wholly or mainly for the purposes of carrying on a qualifying trade or be preparing to do so; a qualifying trade is a trade carried on wholly or mainly in the UK on a commercial basis with a view to profit that does not consist to a substantial extent of certain "excluded activities".
Excluded activities for EMI are the same as for EIS.
Shares subject to the plan must be fully paid-up, non-redeemable ordinary shares in the company; any restrictions attaching to the shares must be notified to participants in the option agreement/or option agreement linked to articles.
To be eligible, an employee must work for the relevant company for at least an average of 25 hours per week or, if less, 75% of the employee’s working time.
An employee who controls, directly or indirectly, more than 30% of the ordinary share capital of the company cannot be granted an EMI option.
The purpose test
Options must be granted for commercial reasons in order to recruit or retain an employee and not as part of a tax avoidance arrangement.
The total market value of shares subject to an unexercised EMI option at any time cannot exceed £250,000 from 2012/13 on (£120,000 for earlier years). Market value is measured at the time of grant for these purposes. If the individual has any unexercised options granted pursuant to an HMRC-approved company share option plan, these count towards the limit. Once the limit is reached, options may not be granted to the individual within 3 years of grant of the last option.
Any number of employees may hold EMI options but the total market value of all shares subject to unexercised EMI options granted by the company or group (measured on grant) cannot exceed £3 million at any time.
Options must be non-transferable, must be capable of being exercised within 10 years of grant and may not be exercised more than a year after death.
Options may be granted at any exercise price or for a nil exercise price.
The main terms of the option must be specified in an option agreement.
These are scheme terms that are individual to each scheme and not laid down by legislation. They will cover vesting and ensure that share options will automatically vest on the occurrence of a sale to a third party or listing on the AIM or recognised stock exchange.
Vesting may be purposefully delayed: an employee will not be permitted to take up his options until he has completed x number of years of service. Alternatively, there could be other performance conditions included, but the more of these the more complex the drafting.
Restrictions When the underlying shares are subject to restrictions this may affect the tax and NICs payable. Restrictions will also affect share valuation.
The EMI legislation sets out certain "disqualifying events":
the company ceasing to be independent or to satisfy the qualifying trade test.
an employee ceasing employment.
altering the terms of an option so as to increase its value.
Tax and NIC treatment of an EMI option Grant
No Income Tax or National Insurance Contributions (NICs) are payable on the grant of an EMI option provided exercise takes place within 10 years from grant and there has been no disqualifying event. Exercise
No Income Tax or NIC are payable on exercise if the option was granted with an exercise price greater or at least equal to the market value of the option shares at the time of grant.
If a nil cost or discounted EMI option is granted, Income Tax will be payable when the option is exercised on the amount by which the market value of the shares at the date of grant (or, if lower, at the date of exercise) exceeds the exercise price.
Where shares are readily convertible assets, Income Tax will be collected under PAYE and both employer’s and employee’s NICs will be due.
The definition of a readily convertible asset is wide. It covers arrangements where an employee may sell for cash.
If a NIC liability arises, the company and the option holder may agree that the employee should bear the liability for the employer’s contributions.
Any increase in the value of the shares between the date of grant and the date of exercise is not charged to Income Tax irrespective of whether the option was granted at a discount or not.
The Income Tax and the NIC relief are partially lost if an option is not exercised within 40 days of a disqualifying event.
Finance Act 2013 extended the 40 day period to 90 days.
Income Tax and NIC are charged on the amount by which the market value of the shares at the date of exercise exceeds the market value immediately before the disqualifying event. The Income Tax charge is limited to the growth in value after the disqualifying event. In the case of a nil cost or discounted option, this charge is an addition to the charge on the discount.
A disqualifying event occurs when the company fails to fulfil any of the following qualifying conditions:
The company loses its independence: the company is controlled by another company, or another company and a connected person.
The company’s trading activities change to include restricted activities, or it mainly trades abroad.
The employee ceases to be in full-time employment.
Changes are made to the terms of the option.
The share capital of the company is altered.
The company’s shares are converted.
A further grant of share options that takes the option holder over the £250,000 2012/13 on (120,000 in earlier years) limit
Tax trap: private equity backed companies and buy-outs
If private equity takes an interest in the company it may no longer qualify for EMI as it may fail the independence test as either:
it will be under the control of another company, or
the articles may be amended to contain provisions that allow private equity to take control if financial performance is not up to standard.
The independence requirement is relaxed following Finance Act 2014: an option exercised in the 90 day period following the acquisition of the company granting the options will still benefit from corporation tax relief under CTA 2009 Part 12.
Sale of shares
On the disposal of the shares acquired under an EMI option, CGT may be payable on any gains made, calculated by deducting the "base cost" of the shares from the net sale proceeds.
The "base cost" of the shares is their exercise price and any amount assessed to Income Tax on exercise. Tax is paid at CGT rate on gains after a deduction of the annual exemption and losses, if available.
CGT Entrepreneurs' Relief (ER)
Following changes introduced in the Finance Act 2013 ER applies to EMI share options.
This change makes some EMI options considerably more attractive to employees who stand to benefits on a 10% rate of CGT on any gains on the disposal of qualifying shares.
The result is that ER now capable of applying to exit based EMI schemes because the qualifying holding period (12 months) can be met if the option was granted 12 months prior to the exit date.
The 2013 changes were applied retrospectively and there are transitional provisions.
For options acquired after 5 April 2012:
There is no minimum shareholding requirement in order for shares acquired under an EMI option scheme to qualify for Entrepreneurs' Relief, so you may hold options/EMI shares than entitle you to less than 5% of voting rights.
The normal 24-month minimum holding period requirement for Entrepreneurs' Relief is modified, this will include the period the option is held, for options granted on or after 6 April 2012.
ER applies to disposals made after April 5 2013.
For 2012/13 there are transitional provisions because there are pooling conditions for shares which were acquired prior to the changes, see HMRC 's analysis http://www.hmrc.gov.uk/manuals/cgmanual/cg64052.htm
Corporate tax deduction
The company will receive a Corporation Tax deduction on the exercise of options granted under an EMI plan, provided that certain conditions are met. The relief is given for the accounting period in which the EMI option is exercised on the difference between the market value of the option shares on the date of exercise and the exercise price.
The levels and bases of taxation and reliefs from taxation can change at any time. Tax relief will depend on individual circumstances.