You may have heard about Enterprise Management Incentive (EMI) Options and that they are a great way to structure a tax-advantaged share option scheme for your employees. But what exactly are they and how do they work?

To keep the favourable tax treatment that makes EMI Options so popular, the scheme must be registered with HMRC and the grant of options must be notified to HMRC within 92 days of the date of grant. This must now be done online using the Government Gateway ERS Online Service which your payroll agent will have access to. Once your scheme is set up and registered, and you have notified HMRC of the options you have granted, you must then complete an annual return each year (which will include details of any updates or developments regarding those options, for example if any have lapsed or been exercised by the employees).

As long as you and your employees continue to satisfy the statutory requirements and follow the HMRC procedures mentioned above the EMI Options should maintain their tax-advantaged status.

So what is the tax advantage?

For the company

Whilst EMI Options are great for employees they also have benefits for the company. When EMI Options are exercised by your team, either at the time of a sale or pursuant to vesting conditions (time or performance related), any capital gain the employee makes on the value of those shares (from the date of option grant to the date the options are exercised) could be deductible for Corporation Tax purposes. This tax treatment will apply in the accounting year in which the options are exercised.

For the employee

There are different stages in the life of an EMI Option which are relevant for tax purposes.

1. Grant of EMI Options

The first stage is the initial grant of the options and at this point in time there is no income tax liability for the employee.

2. Exercise of EMI Options

The next stage is the exercise of options (once they have vested). We would recommend that a share valuation is undertaken and agreed with HMRC when granting the EMI Options but, although this is good practice, it is not a legal requirement. If the employees pay the agreed market value of the shares when they exercise their options there will be no income tax liability at this stage. If the exercise price is less than the market value then there will be an income tax liability calculated on the difference between (a) the market value of the shares under option at the date the options were originally granted, and (b) the price paid for the shares (the exercise price).

3. Sale

Assuming that the value of the shares in the company has grown since the employees exercised their options and became shareholders, when those shares are sold, Capital Gains Tax will be payable. This will be calculated on the difference between (a) the value of the shares at the date the options were originally granted, and (b) the value of the shares at the point they are sold.

Entrepreneur’s Relief should also be available for employees to reduce the rate of Capital Gains Tax to 10%. The usual threshold of 5% of the ordinary share capital and voting rights does not apply when the shares are acquired through an EMI Option but shares must be held for 12 months prior to the sale in order to qualify. For the purposes of shares acquired through an EMI Option this 12 month clock begins on the date the options were granted not the date the shares are actually acquired.

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).

What happens if the company or the employee no longer meet the statutory requirements?

Nearly all of the EMI statutory requirements for both the company and the employee must be met at all times throughout the life of an EMI Option. The exceptions to this relate to the requirements for gross assets, qualifying subsidiaries, material interests, and the number of employees.

If certain requirements do not continue to be met this could amount to a disqualifying events which means that the tax advance will be lost on any gain in value realised after the date on which the disqualifying event occurs. Examples of disqualifying events include an employee reducing his or her hours to no longer satisfy the working time requirements or perhaps the company itself becoming a subsidiary of another.  Entrepreneur’s Relief may still be available regardless of the disqualifying event as long as the options are exercised within 90 days of it occurring. Any gain arising after the disqualifying event will be subject to income tax and NICs on exercise.

But be warned… if the EMI Options are not notified to HMRC, or are exercised more than 10 years after the date they were originally granted, the favourable tax treatment is lost in its entirety!

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