Enterprise Management Incentives
Written by Ray Coman
The Enterprise Management Incentive Scheme offers employees tax concessions on the option to buy shares in their employer’s company. The incentive of tax efficiency improves after two years of ownership as a reward for loyalty. This type of tax advantaged employee share option scheme is available for smaller, unquoted business only.
Capital gains tax implications
Take overs and other disqualifying events
Conditions for the company
The scheme is aimed at trading companies with gross assets of not more than £30 million. The company cannot be involved in:
- The development or management of property, or the provision of hotel or care home services.
- Investment activities such as share dealing, money lending or leasing.
- Farming, legal or accounting services.
The value of shares which are unexercised options cannot exceed £3 million at any time. The company can be quoted or unquoted, with trading activities mainly in the UK. The company must have less than 250 full time employees.
Employee conditions
Any employee or director can participate, provided they work for the company at least 25 hours a week or, if less than 25 hours, for at least 75% of their working time. The options do not have to be available to all employees. However those participating cannot control more than 30% of the company. Each participant can hold options on shares with a value of £250,000 at the grant date. After three years from the date the most recent EMI grant, further options can be issued up to the £250,000 limit.
If the value is greater, the first £250,000 share options will be covered by the EMI rules and the surplus will be taxed following the rules for unapproved share options.
Income tax implications
When the shares are exercised, there would only be a tax liability on the amount by which the shares options were discounted. Therefore, provided the strike price is not less than the market value when the shares are granted, the exercise would give rise to neither income tax nor national insurance.
If the shares are offered at a discount then the income tax is assessed on whichever is the lower of:
- The difference between exercise price and market value when the shares were granted; and
- The difference between exercise price and market value when the shares were exercised.
To put it another way, if shares are worth more than their exercise price it is just the discount (on grant) that is taxable when the shares are exercised. If price has gone down since the shares were granted, it is the difference between the value of the shares and the exercise price. For shares granted at a discount the exercise price could still be cheaper than market value on the exercise date.
Capital gains tax implications
The amount paid for shares, plus any amount subject to Income Tax on exercise, is the base cost for Capital Gains Tax purposes. Where there has been no discount, capital gains tax will be calculated on the difference between sales proceeds and exercise price. Dealing costs are tax deductible.
Business asset disposal relief is usually available on EMI shares:
- It is usually a condition that a person has at least 5% of the shares to qualify for business assets disposal relief. However, there is no minimum shareholding for EMI shareholders.
- To be eligible for the relief, shareholders are usually required to have owned the shares for 24 months. For EMI shareholders, the 24 month minimum holding period starts with the date that the share options are granted.
The effect of business assets disposal relief is that the gain is subject to tax at just 10%.
Take overs and other disqualifying events
A disqualifying event occurs when the company no longer meets the conditions for EMI as explained above. The most common disqualifying event occurs when the company gets bought out. This is because the share of the parent company rarely meets the conditions of being ‘small.’ If new controlling company is listed on the stock exchange the shares will no longer satisfy the conditions of being tax advantaged. In this situation, the EMI shareholder has 90 days from the date of the takeover to dispose of the EMI shares are still obtain the tax relief. If the EMI shares are not disposed of within that time window, they are subject to rules applicable to unapproved shares.
If an employee leaves the company, through redundancy, retirement or illness, a disqualifying event has occurred. The employee has 90 days to dispose of the shares are preserve entitlement to the tax efficiencies particular to EMI. There is no minimum holding period for increase in value to be treated as a capital gain rather than as employment earnings. However, there is a minimum holding period of two years for the business asset disposal relief to apply to that capital gain.
Administration
The company enters into a share option agreement with each employee separately and notifies the details to HMRC within 92 days. HMRC have a facility for self-certifying tax advantaged employment related securities.
Unlike other tax advantaged share schemes, there is no minimum period for which EMI options must be held. The employee must, however, be able to exercise the options within 10 years of their being granted.
The cost of administering an EMI scheme can be deducted from profits for corporation tax purposes.
The tax regulations on the Enterprise Management Incentives are set out in Schedule 5 of the Income Tax (Earnings and Pensions) Act 2003
