Share options can be a cost-effective and tax-efficient way of motivating current employees and attracting new talent to your business. Of the share scheme available, EMI is the most flexible for the average owned company. EMI has numerous tax benefits for both the company and its employees; it is also very flexible in terms of design such that it can be easily structured to meet specific business needs and existing shareholder goals.
A share option agreement is a contractual right to buy a company’s shares in the future, at a price that is fixed today. If the value of the company increases over time, the option holder could be obtaining significant value and make a profit if they exercise their option and then sell their shares. A share sale may occur as a result of an external transaction e.g., third party sale, or via an internal market created by the company – acquisition by an employee benefit trust established by the company. Gains realised on the shares will be taxed at capital gains tax rates and provided the option has been held for at least two years, business asset disposal relief will apply to the gain regardless of the percentage of shares held.
The opportunity to buy shares, to be a stakeholder and benefit in the company’s growth alongside the owners is a powerful motivation for the employee; in general, it is recognised that employees who have share options feel more engaged with the business they work for and are encouraged to work towards its success.
Other than the professional costs involved in setting up such the scheme, and obtaining HMRC agreement to a market valuation, the grant of the options is a non-cash outlay and is therefore a very low-cost way to incentivise employees. In addition, at the point when EMI options are exercised, corporation tax relief is available on the difference between the market value at the date of exercise and the option price paid. This can be very valuable in reducing a corporation tax liability.
Why not just award shares?
For a direct share award employees will pay income tax on the market value of the shares at the date of award. By comparison, if employees are given options under an approved EMI, there is no immediate income tax charge. The proviso is that the option price is at or above the market valuation of the shares on the date of granting the options. This value can be agreed up front with HMRC to ensure there should be no need to negotiate the point later on.
Which companies qualify?
There is a lot of detail in the legislation in relation to qualifying criteria, but broadly a company must:
- Be independent with gross assets of less than £30 million and have fewer than 250 full-time equivalent employees
- Satisfy the qualifying trade test – most trading companies will qualify but there is a specific list of activities which do not
- Have a ‘Permanent Establishment’ in the UK – this is a tax phrase but is basically a fixed place of business
Employees and qualifying shares
Employees who satisfy the qualifying conditions are given options to acquire qualifying shares which must be ordinary shares. An EMI options must be granted for commercial reasons to recruit or retain an employee and not as part of a tax avoidance arrangement. There is a financial limit on the total market value of the unexercised EMI options an employee can hold being £250,000 per employee. Once this limit is reached, options may not be granted to the individual within three years of the grant of the last option.
Any number of employees in the company can hold EMI options but the total market value of all shares subject to unexercised EMI options granted by the company or group, (determined on grant) cannot exceed £3 million at any time
What are the rules on design?
Apart from the tax benefits of an EMI scheme, the further attraction of EMI is the flexibility for designing an option scheme. You can structure the scheme to include many variables:
- The timing of when staff can ‘exercise’ their options and buy their actual shares in all sorts of ways, e.g., they could be allowed to buy their shares immediately, over a period of time or only in the event of a sale of the company
- The type of share which will be issued on exercise of the option – they must be ordinary shares but could share in capital value only over and above a certain value of the company which enables founder shareholders to lock in the existing value they have already built up for their own benefit
- Voting and dividend rights can be restricted
What if an employee leaves?
Another common feature of an EMI option is that they are generally drafted such that any unexercised options lapse where an employee leaves. This means there are no negotiations or complications on recovering a shareholding from a departing member of staff who has not exercised their options.
The rules can be complex and do need some careful thought, but at the same time EMI is a very flexible share option plan. Generally, if you have an idea of what you want to achieve commercially, a scheme can be designed around your requirements. If you do not have an idea of what you want to achieve, we can help you to formulate a plan. Please don’t hesitate to contact me if you would like some help on this matter.