Setting up an Enterprise Management Incentive Scheme

Setting up an EMI Scheme can get complicated which can result in time and money wasted. Having set this up for thousands of businesses, we thought it was time to create a simple to follow guide which can be a good starting point for growing businesses. Our EMI Specialists have worked hard to curate this guide to help you in setting up an EMI share option scheme.

Intense competition amongst startups across the globe creates a huge demand for highly skilled labour. To be better than the next company, employers want to hire and retain the best employees in the market. This demand creates higher expectations from employees in terms of pay packages; money is no longer the only key motivator. Therefore, employers have to think outside the box to design attractive pay packages that incentivize employees to stay for longer and work harder. A few examples of such incentives include Gym Memberships, Free Breakfasts, Health Insurance, Training budgets, etc. 

An effective way for employers to incentivise their staff is through different schemes and plans offered by the government. Small businesses can use different schemes, but the four most advantageous ones in terms of taxes are:

1. Save as you earn plans
2. Company share options
3. Share incentives plan
4. The Enterprise Management Incentive (EMI scheme)

What is an EMI Share Option Scheme?

The Enterprise Management Incentive, or EMI scheme, is a share option scheme backed by the UK Government. EMI schemes are designed to motivate, retain, or compensate employees by giving them a sense of ownership in the business. They are primarily used by small to mid-sized businesses. EMI schemes allow employers and employees to utilise tax advantages. For employees, equity is taxed on the value of the shares at the time they are given instead of when they sell them. Also, when disposed of, the shares are subject to a Capital Gains Tax of 10% on the value of the growth of the shares.  For a comprehensive guide on EMI and comparison options, you can view our in-depth EMI Guide.

• Alphabet Shares Tax Planning, Opportunities and Obstacles

Why do businesses give EMI Share Options to Employees? 

Businesses give EMI Share options to employees because it allows businesses to: 

1. Retain employees over longer periods
2. Reward Loyal employees
3. Motivates employees by giving them a sense of ownership in the business 

How do Businesses Qualify for setting-up an EMI Scheme?

To qualify for the EMI scheme, businesses need to meet the following requirements: 

1. Must be independent 
2. Have less than 250 employees
3. Possess less than £30 million in gross assets
4. Have to engage in a qualifying trade 
5. Should satisfy the commercial purpose test when setting up a scheme

How do Employees Qualify for an EMI Scheme? 

Employees have to meet certain eligibility requirements in order to qualify for an EMI scheme: 

1. Employees cannot have any material interest in the company, meaning they can’t control more than 30% of the company directly or indirectly.
2. Employees need to work at least 25 hours per week or 75% of their working time in the company.

Related: Is the current CGT regime fair? .

Although HMRC can agree to approve company value, HMRC does not review and approve option schemes that come under EMI. To achieve this, make sure that your scheme passes all the qualification requirements for EMI, where the tax treatment follows the legislation for EMI. It can get complicated to set-up a scheme and getting a valuation on the share options, speak to an Accountant who specializes in the process to help you out.

Video: A complete guide to the workings of Enterprise Management Incentive Scheme.

Watch the video to understand the workings of the Enterprise Management Incentive (EMI) Scheme and its qualifying criteria and recent changes in the scheme.

Setting up the EMI Share Option Scheme 

Employee share option schemes can get complicated as various issues need to be considered, such as company law, tax law, and employment law. Sometimes, the language of the scheme is misunderstood by the employer and employee, which can lead to errors, confusion, and employment disputes. 

Consult an Accounting firm that has experience in designing an effective EMI scheme to help make the process easier.

Articles and Rules   

When designing an EMI Scheme, the employer needs to examine the effects of the share scheme on the rights of pre-existing shareholders. They also need to update or amend existing shareholder agreements to include the EMI scheme rules and an option agreement. 

Under an exit-based EMI scheme, business owners don’t have to worry about their employees holding any shares once the company is sold, as their options vest and instantly sell the shares to the buyer. 

In case you decide to offer your employees EMI options that vest over a specific period, you need to make some amendments to your Articles to include the following: 

• Provisions to handle the leaving employee shareholders
• Pre-emption rights for employee shareholders
• Rights of transfer
• Beneficial ownership
• Disputes between shareholders

Once you have worked out and included all the amendments mentioned above, you will need to look into the tax position in accordance with the following key factors:  

• The tax legislation of Part 7 ITEPA, 2003
• The Company Act of 2006
• Formulating your scheme rules
• Vesting conditions to determine when shares can go up
• Those who qualify for shares and those who cannot 
• Dealing with disputes among shareholders
• Leavers
• Valuation
• Takeovers

Related: Learn how you can boost your startup by following our tips.

Tax 

The employer is required to make sure that the EMI scheme is compliant with all tax legislation so that qualifying conditions for the EMI are fulfilled. The employer has to take into consideration what other taxes the scheme interacts with, ensure that all extra NIC charges are covered, and understand what qualifies for Corporation tax relief. Speaking to a specialist Tax Accountant can add value to the process by making sure that you are extracting maximum benefit from the scheme setup.

Related: Learn to claim your tax relief on employment expenses using our guide. 

Valuation 

The market value of your existing shares at the time an EMI option is granted should be agreed upon with HMRC. This should be agreed upon even before any options are granted. Most employers prefer this method because it gives some certainty regarding future tax charges. 

There isn’t a straightforward method to value employee shares because each company is unique. As a result of which, each company may have different scheme rules and company articles that may denote different things. If you overvalue your shares, your employees may get penalized heavily. On the other hand, if you undervalue your shares,  HMRC might reject your valuation. 

It’s prudent that you get the valuation done by either a corporate finance specialist or a recognized Chartered Accountant, as they will follow all required steps and get the required pre-approval from HMRC on the valuation to avoid any future disputes.

Timings

Creating a share option scheme might take some time, but employers must do this properly regardless of how long it takes, as they need to ensure that all of their requirements are reflected in the scheme agreement. It is prudent that employers engage specialists who can help set up scheme rules, amend articles, and aid in passing necessary resolutions. The time involved in setting up these additions and amendments might vary greatly depending on how complicated and bespoke the amendments are. 

Valuations may take several hours or days depending on the company’s size and what information is available in the accounts. 

Planning Challenges

An employer might offer its employees shares in the beginning but then choose to offer EMI options instead. Often, they might set the shares so that if they are acquired, they have little capital value. If an employee discovers that his share options have little capital value, this can have a negative impact on their relationship with their employers. 

That’s why it’s essential that these options have clear vesting conditions that are easy to understand, implement, and calculate. The terms of the scheme should be as transparent as possible. Speak to your accountant to design proper communication around these schemes in order to avoid future challenges.

Compliance with the HMRC

Employers are responsible for informing HMRC electronically through ERS within 92 days of granting the EMI options. If the company has less than 30 employees, then they can inform HMRC directly on their website. If the company has more than 30 employees, they must fill in the notification template before uploading it.

After employers notify HMRC, they will have to file their annual tax returns via ERS at the end of every tax year. This will continue until the scheme expires.

We advise you to speak to a competitive Startup Accounting Firm to get more knowledge about how you can ensure full compliance with HMRC. 

Limitations

According to the legislation, no individual is allowed to have options worth more than £250,000 in a rolling period of three years.

Also, the company is not allowed to have outstanding EMI options worth more than £3 million at any point in time. Any options that exceed the £3 million limit are considered as non-qualifying options.

Exercising options

If an employee wants to exit the EMI scheme, they can after their options have vested over an agreed vesting period. 

If the employer is selling the company, then the employee’s options automatically vest once the company is sold. The exercise can be structured so that it takes place on the same day as the sale. This means that the employee isn’t required to front the purchase price. Alternatively, employers can establish an internal market using an employee benefit trust, which can buy the shares and hold them to grant further options later on. 

This might be attractive if the main point of using the EMI is tax-efficient bonus payments. Of course, the shares could be held and used to receive dividends (if permitted). It will all be down to what employers and their employees are looking to achieve.

Key Takeaway

EMI schemes can be a great option to retain and incentivize valuable employees. However, the language of the scheme needs to be precise in order for it to be effective. Otherwise, ambiguous terms can lead to disputes between employees and employers, which can have the opposite effect on the loyalty of employees. 

Clear House Accountants are specialist services provider for Accountants in London, our in-house Tax Accountants are trained to help you design the most tax-effective solutions for your business and your employees.