Nichola Ross Martin's Tax Consultancy

At a glance

The Enterprise Management Incentive (EMI) is a tax-advantaged share option scheme designed for small companies. A company may grant options to selected employees to allow them to acquire its shares over a prescribed period and provided that certain qualifying conditions are met:

• There is no tax charge on the exercise of an EMI option providing it was granted at market value.
• If the company’s share price has increased in value between the time of grant and exercise the uplift is not charged to Income Tax.
• There will generally be a Capital Gains Tax (CGT) charge when the employee disposes of his shares.

Tax-advantaged status can be lost if the company:

• Does not set up its EMI within the terms of the legislation.
• Fails to notify HM Revenue & Customs (HMRC) of the grant of an EMI option within 92 days.

Or, if a disqualifying event occurs and option holders fail to exercise their options within 40 days.

The directors need to be aware of the type of events that may disqualify a scheme as in most cases they will be able to pre-empt them.

Overview

An EMI share option scheme works as follows:

An employee is granted an option to acquire ordinary shares in his employer’s company (or a qualifying subsidiary). The price of the option is fixed at that date and agreed with HM Revenue & Customs (HMRC). At some time in the future, generally after the employee has worked for a set number of years or the company is listed on a stock exchange or sold to a third party, the employee exercises his option and acquires shares at the price fixed at grant.

• If the price at the grant of the share options was greater than or equal to the market value of the shares at that time there is no tax or National Insurance Contribution (NIC) to pay on exercise. This means that if the company has increased in value between the time of grant and exercise the uplift is received tax-free by the employee.
• If the price of the option is less than market value when granted, there will be a tax charge when the option to acquire shares is exercised: it will be limited to the difference between the market value at the time of grant and the amount paid.
• If the market value at the time of exercise is less than the option because the option itself was offered at less than market value at grant, the tax charge will be based on market value at exercise.
• Provided that there are no trading arrangements in place the employee will not suffer NICs but will pay any tax due on exercise within normal self-assessment time limits.

For example

Date of grant	Date of exercise	Tax due
May 2010	May 2013	31 January 2015
Market value of shares £5 Grant price £3	Market value of share £8	Taxable £2 (£5-£3)

EMI conditions

Qualifying companies

A company can be quoted or unquoted.

It must:

• 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".

Qualifying shares

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.

Eligible employees

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.

Limits

The total market value of shares subject to an unexercised EMI option at any time cannot exceed £120,000. 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.

Standard Terms

• 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.

Bespoke terms

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.

Disqualifying events

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 (NIC) 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. No statutory Corporation Tax deduction is available in respect of their acquisition.
• 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.

Disqualifying event

The Income Tax and the NIC relief are partially lost if an option is not exercised within 40 days of a disqualifying event.

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 fulfill 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 £120,000 limit

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.

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.

Checklists

Checklist – at a glance

This is designed to show you the main steps in setting up an EMI scheme or plan.

• Agree that the company, its employees and shares qualify for EMI.
• Agree qualifying activities with HMRC.
• Agree option terms, vesting, restrictions and scheme rules with the company.
• Design scheme rules and option agreement.
• Make necessary changes to the Articles.
• Ensure Board approval of amendments to articles and pass necessary resolutions.
• Agree a valuation with HMRC (minority holding/restrictions).
• File amended articles with Companies House.
• Board approval of EMI terms.
• Grant of option (executed as a deed between company and employee)
• Notify HMRC EMI 1
• End of year notify HMRC EMI 40 (also form 42 if any other changes made)
• Employee notify HMRC on exercise

Checklist - detailed click EMI: checklist