However, it is important to note that an EMI scheme is just one way of providing share incentives to employees and that there is a plethora of other types of share schemes that are available. EMI schemes remain the first port of call for many companies though; with their unique combination of commercial flexibility and tax efficiency for both the business and the employee.
If you would like any guidance on the most effective share scheme for your company, please contact us for a free consultation.
What is an EMI scheme?
You may see Enterprise Management Incentives referred to simply as an EMI or as an EMI option, an EMI scheme, EMI plan or a mix of some or all of these. In essence, they are one and the same thing.
An EMI scheme is a government-backed share option scheme used predominately by SME businesses in the UK. EMI allows companies to share their success with all or just selected employees in a highly tax-efficient and commercially flexible way.
An Enterprise Management Incentive allows you to reward your key employees while having substantial tax advantages to both your company and your employees. If you are looking to share ownership of your SME business with your employees, then an EMI scheme is a share option scheme that you should consider. As a business owner establishing an EMI scheme you can determine the quantum and extent of employee ownership; including whether to offer voting and/or dividend rights and the extent of to which employees participate in underlying business value.
EMI scheme benefits
A key benefit of EMI schemes is allowing businesses, particularly start-ups and SMEs, to attract and retain the most skilled team possible by giving key employees a sense of ownership in their employing company, its growth and ultimately its financial success.
EMI has been acknowledged in government research as playing an important role in enabling smaller growth companies to compete with more established/larger competitors in the battle for key talent. This can be critical when attracting new employees to your business, if as an SME or start-up, you may not be able to offer a high salary/bonuses. By using EMI employees can still be financially rewarded for their contribution to the business in a more tax efficient way than via salary or cash bonuses.
An EMI option also allows you to involve and reward the people who help your company to grow and be successful and to align your interests with theirs. Participating employees feel more engaged, valued and motivated because they can share in the collective success of the business, so their effort is rewarded in a way that is tax efficient for the business and them.
There is significant scope to create an EMI scheme that matches your commercial objectives. EMIs can take many different forms, including:
- Exit-driven plans - where employees benefit if and only when existing shareholders realise value themselves. These are suitable for business owners who are targeting a sale/listing and wish to motivate their team to work towards achieving that;
- Performance driven plans – where employees are incentivised to meet specific business or personal goals;
- Time based plans – where employees can build up a shareholding over time.
EMI over other share schemes
As mentioned above, there are a wide variety of employees share schemes that are available, each having their own design features and tax effect. In many cases EMI will however be the preferred route due to the combination of:
- Commercial flexibility as described above;
- Deferral of any tax or investment cost for employees and the company (often until value can immediately be realised by employees); and
- Depending upon the design of the EMI scheme and timings, employees paying capital gains tax on the gain they make on the sale of their shares at between 0%-10%; while the company benefits from a tax deduction of 19% on all or part of that gain.
The EMI scheme set-up process
The process to set up an EMI scheme for your business falls into six key stages:
- Establish if your company and employees are eligible for EMI.
- Design the EMI scheme
- File with HMRC for valuation agreement
- Obtain corporate authorisations including establishing employee share pool
- Grant the first round of share options to employees
- Register your scheme with HMRC and report the grant of the options
Establish if your company is eligible for an EMI scheme
Not all companies are eligible for an EMI option scheme. There are specific requirements to qualify and these include:
- Your company (or its group) has a maximum of 249 full-time equivalent employees.
- It, together with its group companies have less than £30m of gross assets.
- It is not controlled by or majority-owned by another company.
- If it has any subsidiaries that it owns over 50% of those subsidiaries (90% for certain types of property management subsidiaries).
- Your company/group carries on trading activities and doesn't carry on certain excluded activities to a substantial extent; these include (amongst other things) farming, banking, legal/accountancy services, leasing or property development.
- Your company or another qualifying company in its group has a UK permanent establishment.
EMI criteria for individual employees
- Any employee (or executive director) added to the EMI scheme must spend at least 25 hours per week or 75% of their overall working time as a company/group employee.
- An employee cannot hold more than 30% of the company shares.
- They cannot hold EMI and certain other types of HMRC approved share options worth more than £250,000. Importantly, this limit is applied when the options are granted and so it does not act to cap employees from benefitting from value in excess of that amount.
- In order to benefit from the reduced 10% rate of capital gains tax when they sell their shares, 24 months must pass between the initial grant of the EMI options and the sale of their shares. This compares favourably with other forms of employee share scheme where the 2-year clock only starts when the shares are actually acquired.
Design your EMI scheme
If you have established that your company and selected employees are eligible for an EMI scheme, it is time to design your scheme. There are various things to consider when designing your scheme, including:
- What are the company’s and existing shareholders’ goals?
- How large should the employee option pool be?
- Who should participate and to what extent?
- When should employees be able to acquire shares?
- How will employees realise value from their shares?
- What is the current valuation of the company?
- Should employees share in existing or just future value?
- What should happen to leavers?
The rules of your scheme and individual option agreements can then be produced and relevant changes made to the company’s constitutional documents (including its Articles of Association and any shareholders agreements).
One of the key elements in the design and implementation of your scheme is to make sure it is fully compliant with HMRC and relevant legal obligations. Non-compliance can be very costly when employees come to exercise their options and makes obtaining proper professional advice in advance of and during the implementation process a must.
The business owner or their adviser should then file with HMRC to get an EMI share valuation. The valuation is only normally valid for 90 days (extended currently for 120 days during the Covid pandemic). The valuation will help to provide you with clarity of HMRC’s view on valuation, where to set the option price and the tax treatment of the options moving forward.
Obtain corporate authorisations
The next stage, once the valuation is agreed, is for you to implement the corporate framework to grant the options. This can involve establishing new Articles of Association, authorising the employee share pool and getting relevant internal approvals from the company’s Board of Directors and shareholders.
Granting the options
Finally, you've ticked all the boxes, and you can start issue or grant options to selected employees. This involves the company entering into a formal deed, communications with employees and signing the relevant option agreements.
Registering with HMRC
The final hurdle to cross in implementing an EMI scheme is to ensure your scheme is registered with HMRC and the grant of the options is notified to HMRC. This has to be completed with 92 days of granting the share options.
Year end reporting is also required to HMRC by 6 July following the end of each tax year to summarise activity within the scheme during that tax year.
EMI options are extremely tax-efficient for both the business and the employees issued with the options. For businesses, by offering an EMI scheme, you may be eligible for corporation tax relief on the growth in value of the shares under option which helps you to minimise your corporation tax liability.
For the employees, initially receiving the options via an EMI scheme gives rise to no tax up-front. Provided that the option shares are bought for the market value agreed with HMRC there should also be no tax when the options are exercised and the shares under option are actually acquired by the employees. Depending on the size of the gain an employee makes, tax may be payable on the ultimate sale of the underlying shares. This gain is usually subject to capital gains tax (or CGT). Each employee may be able to use their annual CGT allowance to exempt the first £12,300 of any gain from tax. As noted above, a 10% rate of CGT (rather than the standard 20%) can then apply to any further gain made on the sale of the, provided that the shares are sold after 24 months or more from when the options were originally granted.
Once EMI options have been granted with appropriate professional support, the tax breaks on offer should be capable of being secured. However, there are certain post-grant events that can have a significant impact on the tax efficiency of EMI schemes - these are known as disqualifying events.
The most common disqualifying events are changes to certain of the original qualifying criteria, for example, this could be a change to an employee's working circumstances, a change of control within the business or a change in the company’s trading activities; for example, if the business moved substantially into one of the excluded activities categories. A grace period applies following the happening of disqualifying events, however this is relatively limited. It is therefore important to keep a watching brief on relevant events which may impact on EMI options and obtain relevant advice in advance of carrying them out.
For full details of EMI disqualifying events, please see our article.
Managing an EMI option scheme
Once your EMI scheme is designed, set up and launched with your initial participating employees, you will need to review and manage it on an ongoing basis. This may include adding new qualifying employees when you see fit. For those employees who leave the business their options may lapse automatically or action may be required to forfeit their options and/or clawback any shares that they hold depending upon how the scheme is designed.
As Enterprise Management Incentives (EMIs) are relatively quick to set up, taking on average six to eight weeks to implement and rollout across a business.
Setting up an EMI option scheme involves proper design and thinking through a number of “what-ifs”. However, we can assist you with the process to design and set up your scheme to ensure you are compliant and avoid unnecessary delays or costs.
We can manage the entire process for you, including qualification review, design, liaising with share valuers, C implementation, communication and rollout of your scheme and HMRC registration and notifications.