This is a freeview 'At a glance' guide to designing an EMI share option scheme.

For more detailed guidance see our subscriber guide, EMI: Enterprise Management Incentive scheme

Designing an EMI share option scheme

  • A share option scheme should be designed to both motivate and reward your key employees.
  • The Enterprise Management Incentives (EMI) code allows for the creation of tax-efficient share options which can be ideal for new and growing companies, or as a method of passing on shares in retirement.
  • The employee is awarded EMI share options which they may convert into shares either immediately or at some time in the future, or on the sale of the company.
  • The options provide an incentive to aid employee performance as the price of the share is fixed for tax when the options are granted and any gain in the value of the company between the date of grant and exercise of the option escapes Income Tax and falls into the more favourable CGT regime.

HMRC do not actually approve option schemes under EMI, although they do agree the company value. The employer ensures that their scheme qualifies for EMI. Providing it does, the tax treatment is in accordance with the legislation for EMI.

Setting up a share scheme or EMI share option scheme

  • Employee share schemes or share option schemes are complicated because the employer will have a range of issues to consider, stretching from company law to tax law, with perhaps some employment law to consider too.
  • It is extremely common to find that both the employer and participant do not fully understand the terms of a scheme.
  • Schemes can be exit-based: i.e. your option vests when the company is sold, or they can allow employees to obtain shares over a period of months or years.

Articles and rules

The employer will need to consider the effect of a share scheme on existing shareholders' rights and perhaps amend existing shareholder agreements, as well as setting up the EMI scheme rules and an option agreement.

An exit-based EMI scheme means that you do not have to worry too much about having employee shareholders as they will only hold their shares for a fraction of second; their options vest and they instantly sell out to your buyer.

If you are offering EMI options and these vest over time you will need to amend your Articles to include provisions to deal with leaving employee shareholders including death, pre-emption rights, rights of transfer and beneficial ownership and disputes between shareholders (if you are a pessimist!). Having worked out that you then need to look at the tax position and if necessary modify your plans to suit.

Key factors:

  • Tax legislation: Part 7 ITEPA 2003.
  • Companies Act 2006.
  • Creating your scheme rules.
  • Vesting conditions (when shares can be taken up).
  • Who can and can't have shares.
  • How you deal with disputes amongst shareholders.
  • Pre-emption rights.
  • Takeovers.
  • Leavers.
  • Valuation.
  • Death.

Tax

  • The employer will have to follow the relevant tax legislation to ensure that the qualifying conditions for EMI are met.
  • It will then have to consider what other taxes interact and ensure that it has covered extra National Insurance Contributions (NICs) charges and understands what will qualify for Corporation Tax relief.

Valuation

  • The market value of the company's shares at the date of the grant of an EMI option has to be agreed with HMRC.
  • It can be agreed before options are granted, which most employers find is preferable because it provides certainty about future tax charges. 
  • There is no simple or fast way to value employee shares because each company is different and scheme rules and company Articles may all do and say different things.
  • Overvalue your shares and your employees may lose out, undervalue your shares and HMRC may reject your valuation.

Timings

  • It takes some time to set up a share option scheme but it is critical that time is allowed to talk to the employer to see exactly what they want.
  • Setting up the scheme rules, amending articles and passing necessary resolutions will take as long as it takes, normally the best part of a day, but it may be longer where you wish to create bespoke articles and several shareholders as there may be a variety of other issues to consider.
  • Valuation may take four or five hours or several days depending on the size of the company, the accounts and what information is available.

Planning issues

  • An employer may start with a desire to offer employees shares, then decide on EMI options but set these so that the shares, if ever capable of being acquired, carry so many restrictions that they often have little capital value.
  • If an employee realises that his share options are of low value it can have a negative effect on his relationship with his employer.
  • An employer will want to consider vesting conditions and then ensure that these are easy to understand or calculate and as well as implement.

Health warning

A share or share option scheme should be approached with great care. If not, the result may be something that does not make sense and it could make life very complicated and difficult for the company and its shareholders if there is later a dispute over the agreement or shareholders fall out.

If you would like assistance in designing a share scheme or share option scheme, we advise advisers as well as employers, so please contact the Virtual Tax Partner Support service.


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