An Enterprise Management Incentive (EMI) Option Scheme can be particularly attractive to start-ups and high-growth companies on account of the substantial tax benefits available for employees. Options over shares can be granted by employers for the purpose of recruiting and retaining employees, often where salaries and bonuses cannot be paid at the same level as larger competitors.
In summary, the tax advantages available for employees are:
- no tax is payable on the grant of the option
- no tax is payable on the exercise of an EMI option as long as it was granted at market value
- Capital Gains Tax is only payable when the employee disposes of the shares and the proceeds of sale exceed the market value as at the date of grant
- Entrepreneur's Relief may be available on the sale of shares which can reduce the rate of capital gains tax to 10% if the option was granted at least 12 months before the sale
It may also be possible for the company to take advantage of a corporation tax deduction available when EMI options are exercised by an employee.
Who can participate?
Employees and directors can qualify for EMI options. However, there is also a requirement that ‘eligible employees’ work for the company for at least 25 hours per week, or if less than this, 75% of that employee’s total working hours in order to qualify. This often means that non-executive directors will not be eligible, along with consultants.
Employees in receipt of EMI options are not permitted (whether alone or together with their associates) to own or otherwise control more than 30% of the ordinary share capital of the company issuing shares.
Does my company qualify?
Most technology companies in growth phase will meet the qualifying criteria (gross assets of less than £30 million and less than 250 employees), although they will need to ensure that they are independent and do not carry out one of the following excluded activities:
- dealing in land;
- banking and insurance;
- property development; and
- legal services.
Employees will be permitted to hold unexercised EMI options over shares worth up to the ‘individual limit’ in force at that time. The current limit is £250,000. The company will also be subject to a cap in relation to the number of options that can be granted. The current maximum is £3million worth of shares at any one time.
The only restrictions in relation to the exercise of EMI options are that the option holder must be able to exercise the options within 10 years of the date of grant, or if the option holder dies within this period, within 12 months of their death. This means that the employer has a considerable amount of flexibility in relation to whether to include performance or vesting criteria, with many early stage technology companies choosing to keep things simple with an exit only scheme.
Process and Deadlines
In order to avoid any nasty tax surprises at a later date, we would recommend that companies agree a valuation with HMRC. As Stephen set out in a previous blog on ‘How do I set a share option price’, it is worth noting that HMRC are not constrained by the last price paid by any investor and may agree a valuation for ordinary shares to be held by employees which is below the price paid by investors. If the share value is agreed with HMRC, the company has 60 days within which to grant options from the date that HMRC confirms that value. The company will be free to use its own valuation without HMRC confirmation but this comes with the risk of being challenged later on by HMRC.
Once EMI options have been granted, companies must register online with HMRC (if they haven’t already done so) and complete the HMRC electronic notification process within 92 days of the date of grant.
Failure to notify HMRC within the timescales will result in the options being treated as non-qualifying for tax purposes.
Annual Return and Late Filing penalties
Online returns should be filed annually (no later than 6 July after the end of the relevant tax year) by companies operating an EMI Option Scheme. HMRC requires details of the exercise of any EMI options and also details of any release, lapse, cancellation, rollover or adjustment of the options to be reported in the return.
For late returns, an initial fixed penalty of £100 will be awarded with further penalties of £300 after 3 and 6 months. After 9 months, HMRC may impose penalties of up to £10 per day.
Nil returns should be submitted by companies with a registered EMI scheme where there are no outstanding options or where nothing has happened in the previous tax year. Non-filing penalties will be imposed if the company fails to do so.
Penalties of up to £5000 for material inaccuracies in returns can also be imposed by HMRC if these are not corrected ‘without delay’ by an amended return.
For companies not eligible for EMI options, there are other tax-advantaged schemes to consider but for those that do fit the bill, an Option Scheme can help motivate and encourage employees to further the interests of the company for everyone’s benefit and allow them too to reap the rewards.
While the above is only a brief introduction, feel free to email any queries to me at email@example.com