Incentivising employees is key and often a startup does not have enough revenue to be able to pay employees market rate salaries. The alternative is to give employees a share of the equity of the business. However, this can give rise to very significant tax liabilities if structured wrongly.
Enterprise Management Incentive (“EMI”) options are tax efficient options for employees in smaller, high risk companies. The intention behind the EMI legislation was to help companies recruit and retain the highest standard of individuals.
EMI options can be granted by any company or any shareholder (meaning that the shares used to satisfy EMI options can be transferred by a shareholder rather than issued as new shares). The shares can also be granted over shares of a company incorporated outside the UK providing that the following requirements are met:
- the gross assets of the company must not exceed £30,000,000 at the time of grant.
- the company must be an independent company (meaning that it must not have any holding companies).
- the company must only have qualifying subsidiaries (meaning that they are owned and controlled by the company).
- the company must have fewer than 250 fill time employees.
- the company must have a UK permanent establishment (meaning that it must have a fixed place of business in the UK).
- the company must be a trading company (or the parent of a trading group) carrying on a qualifying trade.
A qualifying trade is one that is undertaken on a commercial basis with a view to making profits. It must not consist of certain excluded activities making up more than 20% of the trade carried on by the business.
The excluded activities are similar to those under SEIS and EIS (such as property businesses, lease and rental, financial services etc).
What type of shares can be acquired under an EMI option?
EMI options must grant rights to acquire non-redeemable, fully paid up, ordinary shares. The fully paid up requirement is important as it means that the exercise price for the shares must be paid in full at the time of exercise.
Shares are treated as redeemable if they may become redeemable at a future date.
Which employees can be granted EMI options?
Employees must spend an average of 25 hours per week on the business of the company or 75% of their total working time if they are self-employed for work elsewhere. Employees who have no other remunerative employment or self-employment of any kind are also eligible for EMI options.
EMI option holders must not hold 30% or more of the shares in the company or control 30% for more of the voting rights. The shares to be issued pursuant to the exercise of the EMI options are included in the 30% calculation.
Non-executive directors are not eligible for EMI options.
Requirements of the options
The EMI options must take the form of a written option agreement between the grantor (the company or the employee) and the employee. Options must be capable of being exercised within ten years after the date of grant.
Options must not be capable of transfer to third parties and must not be exercisable more than one month after the date of the death of the employee.
The maximum amount of unexercised EMI options at any point in time must be no more than £3,000,000. No individual employee can hold shares (and unexercised options) in the company with a market value in excess of £250,000.
A company must seek an approval from HMRC of the value of the company (and therefore the value of each share prior to issue of EMI options. This valuation is valid for 60 days during which time the options must be granted.
The company must notify HMRC of the grant of EMI options within 92 days of the date of grant.
The company is entitled to a corporation tax deduction when EMI options are exercised. This is equal to the gain on exercise that would have been taxable on the employee has the option not been an EMI option.
On grant of the option, there should be no tax implication for the employee.
On exercise of the option, if the exercise price equals the actual market value of the shares at grant (as agreed with HMRC), there should be liability to income tax so long as the option is exercised within ten years after the date of grant or a disqualifying event has not occurred.
Disqualifying events include the sale of the company, the company ceasing to trade, the employee ceasing to meet the working time requirements, the employee ceasing to work for the business, certain variations to the EMI option and certain conversions of the shares under option.
Note that EMI does not provide income tax relief on any surrender of the EMI option for consideration.
On disposal of shares resulting from exercised EMI options, the difference between the market value of the shares at the time of sale and (at a high level) the exercise price paid by the employee on acquisition of the shares is subject to capital gains tax.
Entrepreneurs’ relief may be available to the employee so long as the options were granted more than 12 months prior to disposal and the company is a trading company between the date of grant and disposal of the shares. The option holder must have been an employee and director for the entire period between the date of grant and disposal.
Buckworth can advise on the suitability of, and setting up, EMI options. Please contact the team for more information.
Tel. 020 7952 1721