So we know that Enterprise Management Incentive (EMI) Schemes are tax-advantaged, but what exactly does this mean?

In order for EMI options to maintain favourable tax treatment, the scheme (whether under a set of rules or a one-off stand-alone agreement) must be registered with HMRC. Once the scheme is registered, the grant of options must then be notified to HMRC within 92 days. This must be done online (either by the company of their payroll agent) using the Government Gateway ERS Online Service. Thereafter, a yearly annual return must be filed to update HMRC with any developments (for example the exercise or lapse of any of the options). As long as all the requirements are met (see our previous blog for the statutory requirements) then the tax advantages set out below should remain.

Tax advantages for the employee

There are likely to be many stages in the life of an EMI option, from the initial grant, the exercise of the option (at which stage the option holder becomes a shareholder) and then finally when the shares are sold. The tax treatment at each stage is discussed below:

• 1) At the point in time that the options are granted (i.e. the date the EMI Option Agreement is signed) there is no income tax liability for the employee.

2) It is good practice (although not legally necessary!) for a valuation of the shares in the company to be agreed with HMRC prior to the grant  of the options. As long as the options are then exercised at a price at least equal to the market value of the shares, then there will be no income tax liability for the employee on exercise.

If the exercise price is less than the market value, then income tax will be payable by the employee on the difference between the price they pay for the shares (exercise price) and the market value (at the date of grant).

3) When the option shares are sold (and assuming that the value of the option shares has increased since the date of grant of the option), Capital Gains Tax will be payable by the employee on the difference between the market value at the date of grant and the value of the shares at the point they are sold.

One further tax-advantage of shares acquired through an EMI option is that they will qualify for Entrepreneur’s Relief, which is not usually the case unless the shares represent over 5% of the ordinary share capital of the company. The other conditions relating to Entrepreneur’s Relief will apply, including the 12 month period in which the shares must have been held. For EMI purposes though, this 12 month period begins on the date of grant (not the date the options are exercised and the employee becomes a shareholder).

 National Insurance Contributions will not be payable at any stage as long as no income tax is due and the option shares are not “readily convertible”. This means that the shares must not be freely saleable (for example shares in a subsidiary, share capital other than ordinary shares, or redeemable shares).

Tax advantages for the company

At the point that the EMI options are exercised by the employee, any gain the employee makes (so the increase in value from the date of grant to the date of exercise) may be deductible for Corporation Tax purposes in the accounting year in which those options are exercised.

In the event that the company is to be sold, as long as any options are exercised within 90 days of the change of control, then the same relief should be available.

Can the tax advantages be lost?

The statutory requirements must be complied with at all times (save for the requirements as to gross assets, qualifying subsidiaries, material interests and the number of employees) throughout the life of an EMI option. So if the company becomes a subsidiary of another, or ceases to carry on a qualifying trade, then the tax advantage will be lost. In addition, the working time requirements applicable to the employees must continuously be met. Certain re-organisations of the share capital in the company may also be a disqualifying event for these purposes.

If a disqualifying event does occur during the life of an EMI option, any gain up to that point in time will retain its tax favourable status, however Entrepreneur’s Relief may be lost (if the option is not exercised within 90 days of the disqualifying event) and any gain arising after the event will be subject to income tax and NICs.

For further information on employee share schemes, please do not hesitate to contact an Everyman Legal Solicitor on 01993 893620 or email everyman@everymanlegal.com