Designing and Setting-up an Enterprise Management Incentives (EMI) Share Option Scheme
A complete overview of the EMI scheme
Intense competition amongst startups across the globe creates a huge demand for highly skilled labour. In order 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:
- Save as you earn plans
- Company share options
- Share incentives plan
- 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 it is given instead of when they sell them. Also, when disposed of, the shares are subject to Capital Gains Tax of 10%.
Why do businesses give EMI Share Options to Employees?
Businesses give EMI Share options to employees because it allows businesses to:
- Retain employees over longer time periods
- Reward employees who are loyal
- 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:
- Must be independent
- Have less than 250 employees
- Possess less than £30 million in gross assets
- Have to engage in a qualifying trade
- 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:
- Employees cannot have any material interest in the company, meaning they can’t control more than 30% of the company, directly or indirectly.
- 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 Working of Enterprise Management Incentive (EMI) Scheme and its Qualifying Criteria and Recent Changes in Scheme.
Setting up the EMI Share Option Scheme
Employee share option schemes can get complicated as there are a variety of issues that 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, confusions and employment disputes.
Consult an Accounting firm that has experience in designing an effective EMI scheme to help can 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 with EMI options which vest over a specific period of time, you need to make some amendments to your Articles in order 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 have to need to look into the tax position in accordance to 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
Related: Learn how you can boost your startup by following our tips.
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 NICs 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.
The market value of your existing shares at the time an EMI option is granted should be agreed upon with HMRC. It’s advisable that this is 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.
Creating a share option scheme might take some time but it is necessary for employers to 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.
An employer might offer it’s employees shares in the beginning but then choose to offer EMI options instead. Oftentimes, 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 to inform 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, then they need to 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 business accountant to get more knowledge about how you can ensure full compliance with HMRC.
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.
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.
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 amongst employees and employers which can cause the opposite effect of loyalty from employees.
Clear House Accountants are specialist 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. Speak to us to see how we can help.