The Enterprise Management Incentive (EMI) is the UK share option scheme focused on growing companies that want to reward and incentivise their employees.
- An EMI gives employees the option to buy an agreed number of shares in a company at a fixed price and at a fixed date.
- This option to buy shares may be based on the employee meeting meet certain criteria, such as performance targets, upon the sale of the company, or simply after staying in the company for an agreed period.
- An individual company must also meet certain conditions to qualify for the scheme.
- An EMI gives certain tax benefits to the employee.
The scheme has been very popular in the UK, where it is seen as a key reason behind the country’s success as a hub for start-ups.
Skip to the relevant section:
- How does an EMI work?
- How do you qualify for an EMI?
- The benefits of an EMI for an employee
- The benefits of an EMI for an employer
- What is an EMI disqualifying event?
- The tax benefits of an EMI
- Enterprise Management Incentives, Simplified
How does an EMI work?
One of the main benefits of an EMI is that they are very flexible in their design
EMIs are very flexible in their design, so in practicality, they can work in lots of ways. First, your company has to qualify for the scheme.
Once you qualify, it’s simply a matter of deciding how you structure them. The aspects of the plan you need to consider include:
- Which employees can be part of the scheme.
- How many shares each employee can be offered (there are limitations here).
- Will the rewarding of shares be based on employees meeting agreed criteria, like performance targets or on sale of the company?
- Will you offer a discount to employees over the regular share price? Essentially, you need to decide how much will employees have to pay to acquire their shares.
- What type of shares are to be sold – will they be ordinary shares, non-voting shares etc.
- Share options must be exercisable within 10 years.
- Your ‘good leaver’ and ‘bad leaver’ rules (what happens when an employee leaves the company).
Companies will usually work with an expert advisor to structure the plan and draw up formal agreements for the company and employees to agree to.
Importantly, you must notify HMRC within 92 days about the option grant. You should also agree on the market value of the shares with HMRC in advance so you can give your participants certainty about the tax treatment they’ll receive when they excise their shares.
How do you qualify for an EMI?
There are a few straightforward conditions your company has to meet in order to qualify for an EMI:
- The company must have assets of £30 million or less.
- The company can only offer up to a maximum of £250,000 of share value per employee and £3 million for the whole company.
- The company must be independent i.e. not owned by another entity.
- The company must have fewer than 250 full-time employees.
- It cannot work in any of the ‘excluded activities’ including banking, insurance, farming, property, legal services, hotels and care homes, and shipbuilding.
- Options must be exercisable within 10 years.
Beyond the company itself, individual employees must also meet certain criteria to qualify for the scheme:
- They must work at least 25 hours per week for the company or, if less, at least 75% of their working time. This also applies to company directors.
- Employees cannot qualify for the scheme if they already own 30% or more of the company.
The benefits of an EMI for an employee
An EMI scheme can be very financially beneficial for an employee
At the larger level, an EMI allows for employees to build their financial portfolio more efficiently than through regular income, have a more diversified financial portfolio, and become part-owners in their business.
More specifically, if you’re a participant in an EMI you do not have to pay Income Tax or National Insurance if you buy the shares for at least the market value that they when you were granted the option. If the company offers a discount on the market value (this happens regularly) then you will have to pay Income Tax or National Insurance, but only on the difference between what you paid for them and the true market value.
If you sell the shares, you may be liable to Capital Gains Tax (depending on the value that you bought and sold them at). However, even here, the Capital Gains Tax rates are lower than normal income tax rates, so it’s an efficient way to invest.
The benefits of an EMI for an employer
As with all incentive plans, an EMI will help attract and retain talent, improve productivity within individuals and teams, and help create a shared culture within a company.
As the EMI is directed towards start-ups and growing businesses, it is often used to attract key talent because these sorts of businesses can’t match the salaries on offer at more established enterprises. The generous tax benefits and terms on offer from HMRC make it less of a financial risk for those employees to take less salary vs more share options and offers the potential for large profits if the business becomes successful.
What is an EMI disqualifying event?
Essentially, the risk in an EMI comes with not filling in the paperwork properly. By not following one of the steps to be legally compliant, the tax benefits of the plan can be lost.
Here is a (non-comprehensive) checklist of some common areas where companies go wrong:
- They didn’t notify HMRC correctly.
- They stop meeting the qualifying conditions over time i.e. a company assumes that because they’ve met the criteria one year, they will continue to meet them every time they offer share options. This may not be the case, however, with changes such as new ownership, asset growth etc.
- The restrictions on the type of shares being offered were not fully disclosed to the HMRC.
- Have option holders signed working time declarations? Each option holder must sign a written declaration that they meet the working time requirement. Before April 2015, this was not required, and some schemes have not taken this into account.
There are also what is known as ‘disqualifying events’ which can cause options to lose some or all of their EMI tax benefits, including:
- The company acquires new ownership and ceases to be independent.
- The employee not working the minimum amount of time for the company anymore.
- The company changes its focus and enters a ‘disqualified’ trade.
- An employee retirement.
The onus is on the individual companies to continually analyse their plans, inform HMRC of any changes and therefore minimise the risks of their employees not receiving the rewards they had been promised.
The tax benefits of an EMI
The tax benefits of an EMI are considerable. Participants will not have to pay Income Tax or National Insurance if they buy the shares for at least the market value they had when granted the option.
Income Tax or National Insurance will have to be paid if the participant was given a discount on the market value, but this is only applied to the difference between what the participant paid and what the shares were worth on the open market.
There are Capital Gains Tax liabilities when a participant sells the shares, but the Capital Gains rate (10%) is significantly lower than Income Tax (up to 45%).
When we compare a person who participates in an EMI scheme, and then compares what they would pay in Income Tax for the same income, we can see the impact it can have on an individual’s financial portfolio.
Jane (EMI Scheme)
John (Ordinary Income Tax)
Jane is granted an EMI option to acquire 1% of her employer company for £20,000
John is offered £50,000 per year annual salary in a new start-up
4 years later, Jane sells the shares for £200,000, paying no tax when option is granted or when option is exercised.
Over four years, John is paid £200,000 in ordinary income
When she sells the shares, Jane pays Capital Gains on the £180,000 (the sale price minus the option price). Capital Gains is charged at 10%, so Jane pays £18,000 in tax.
In total, John pays approximately £49,000 in tax over the four years.
When we look at the above example (and this is without accounting for any base salary to supplement the EMI scheme) we can see that EMI schemes can be very attractive for ambitious professionals.
Of course, this assumes that the company’s value (and the share options themselves) goes up during the time of the EMI scheme. But this is the risk that the employee is taking – they are looking for higher payoffs for that risk.
Enterprise Management Incentives, Simplified
For small, the growing company’s an EMI is a brilliant way of attracting, retaining and motivating top talent that may otherwise be out of your financial reach.
However, as with all tax-advantageous incentive plans, there are risks attached. The HMRC needs to ensure that the right companies are benefiting from the scheme and getting the technicalities right can be the difference between a successful plan and an unsuccessful one.
Working with experts like here in Global Shares and using our enterprise incentive management software, you can rest assured that you are taking full advantage of the benefits on offer and continue to do so as you grow as a company.