What is an EMI share option plan?
EMI stands for “Enterprise Management Incentive”.
Like any share option plan, an EMI plan involves giving an employee a contractual right (an option) to acquire shares at some point in the future for a specified price.
However EMI plans offer significant tax advantages to other forms of option plans.
An EMI option can be thought of as a form of “tax wrapper” for a standard share option plan in the same way as an ISA is really just a tax wrapper for a standard bank account.
Employers like EMI options as they offer a flexible incentive and remuneration tool. The employee’s right to acquire shares can be made conditional on meeting performance targets or the occurrence of a specified event (for example, the sale or listing of the company). The arrangements can also provide for the option to lapse, or require the employee to sell back any shares the employee has already acquired, if he leaves the company.
EMI options are also attractive to employees as they provide the employees with the potential to participate in any growth in value of their employer in a tax efficient manner without any upfront cost or risk.
What are the tax advantages?
EMI options can be very tax efficient for both the employee and employer.
For the employee:
- there should be no tax on the grant of the option;
- there should be no tax on exercise either, provided that when the option was granted the exercise price was set no lower than the market value of the shares at that point;
- the tax charge is instead deferred until the shares are actually sold (at this point the difference between the exercise price and the sales price is subject to Capital Gains Tax);
- the applicable Capital Gains Tax rate is usually only 10% (even for higher or additional rate taxpayers). This is because shares acquired via EMI options will generally qualify for entrepreneurs’ relief as the usual qualifying conditions for this relief are relaxed (e.g. there is no need to hold a 5% stake in the company so even employees acquiring a small number of shares can benefit from this relief); and
- the EMI tax treatment compares favourably to non-tax advantaged options. With non-tax advantaged options the employee’s profit is subject to Income Tax at the employee’s marginal rate when the option is exercised (this can be as high as 45% and in some cases a 2% employee national insurance charge will also be applicable).
For the employer:
- Corporation Tax relief should be available when the EMI option is exercised on the difference between the exercise price paid by the employee and the market value of the shares at exercise. This can be an extremely valuable relief for companies that have grown quickly since the option was granted; and
- there should be no employer national insurance contribution (NIC) charge on the grant of exercise of the options. Employer NIC charge is currently 13.8%, so this can represent a significant saving compared to non-tax advantaged options (or indeed cash remuneration).
What sort of company might consider using EMI options?
EMI option plans should be of interest to both private trading companies and smaller AIM listed entities.
EMI option plans are flexible and can be designed to deal with concerns about the control of the company or the marketability of the company’s shares. For example, many founder shareholders (particularly in owner managed businesses or family companies) do not wish for shares to be held by ex-employees. This sort of concern can be dealt with by providing for the option to lapse when an employee leaves a company and the company’s articles of association could also be amended so that a departing employee shareholder is forced to sell any shares they hold.
It is also possible to create a new class of shares, for example with no voting or dividend rights, specially for use with the option arrangements.
Private companies are sometimes concerned that share options would not offer an attractive incentive to employees as there would be no ready market for them to sell any shares acquired. However EMI option arrangements in private companies are often linked to an “exit event” whereby options can only be exercised on a sale or listing of the company. This means that questions of marketability are not a problem in practice. Moreover it is also possible to create internal markets for the shares if required. Private companies sometimes establish employee benefit trusts for this purpose whereby the trust can act as a buyer and seller of employee shares (for example acquiring shares forfeited by departing employees and then recycling these shares for use in the plan by making grants to new joiners).
The EMI tax advantages were introduced by the Government to help smaller, higher risk companies recruit and retain employees. To ensure the tax incentives are correctly targeted the company and the option holder must meet certain eligibility criteria.
In broad terms the main conditions for the company are that:
- it must be trading company, carrying out a qualifying trade, or the parent company of a trading group (non-qualifying trades include dealing in land, receiving royalties, hotel management and similar high asset backed businesses as well as certain professional services);
- it (or its group if applicable) must have fewer than 250 full time employees; and
- its gross assets (or its group’s if applicable) must be less than £30m.
In addition the option holder:
- must be an employee of the company or a subsidiary (consultants cannot qualify);
- cannot own more than 30% of the employing company; and
- must work at least 25 hours per week for the employing company or, if fewer than 25 hours, then 75% of their total working time.
How could Fladgate help?
Fladgate has considerable experience in setting up EMI option plans for both private and AIM listed companies and we are well placed to assist with both the legal and taxation aspects of share option arrangements.
John Forde, Partner, Fladgate LLP (firstname.lastname@example.org)