For companies with UK employees, Enterprise Management Incentives, more commonly known as EMI options, can often be their first choice when it comes to offering a share plan to employees.
There are a number of reasons for this, explain Martin Cooper, Partner at RSM UK and Kerrie Willis, Director, at RSM UK, an experienced provider of audit, tax and consulting services to the middle market.
“EMI options are one of the most attractive forms of share option from a tax perspective anywhere in the world, with qualifying employee gains being exempt from income tax and instead being subject to Capital Gains Tax (CGT), with the gain often benefitting from Business Asset Disposal Relief, taxed at a rate of 10%,” says Martin Cooper. “For employers, gains on qualifying EMI options are generally exempt from employer’s National Insurance and qualify for a valuable corporation tax deduction, therefore potentially delivering a cash benefit to the company worth 25% of the gain.”
Since EMI options are aimed at small and medium sized businesses as companies grow they may find that at some point they can no longer offer these to staff.
What are the restrictions around setting up an EMI?
There are many different requirements and factors that need to be met in relation to EMI options, such as the company itself, its trade, the particular employees to be granted awards, and the terms of the option.
The key limits which Martin Cooper urges companies to be aware of are:
- Only companies with fewer than 250 employees can grant EMI options. This limit is tested at the moment of grant, and is based on the number of full-time equivalent employees in the parent company and its qualifying subsidiaries (including non-UK employees). Generally, an employee who works 35 or more hours a week will count as one full-time employee, with part-time employees counted based on the fraction of a 35-hour week that they work.
- Gross assets must not exceed £30m for a company to be entitled to grant EMI options. Again, this limit is tested at the moment an option is granted. For group companies, it is the value of the group’s gross assets that the limit is applied to; applying the gross assets test to groups can be complex, and specialist advice should be taken by companies who are close to this limit.
“Exceeding these limits will not cause the tax advantages for existing EMI options to be lost, but it will prevent a company from granting any new EMI options while they remain above these levels,” says Kerrie Willis.
What if a company is too big to grant EMI options?
The most straightforward solution where a company has grown too big to grant any further EMI options is to continue granting options under the existing share plan but accept that these will now be treated as ‘unapproved’ options and won’t benefit from the EMI tax advantages.
“This route is unlikely to be attractive from a tax perspective,” says Kerrie Willis. “Unapproved options in the UK are taxed at exercise to income tax on the whole value of the gain at the employee’s marginal rate (up to 45%) and usually National Insurance contributions will be payable (typically 2% for the employee and 13.8% for the employer). Apprenticeship Levy may also apply (0.5%). But the good news is that there are several more structures available which might be more attractive from a tax perspective.”
CSOP options are the most similar UK structure to EMI options. They are another form of share option that, like EMI options, benefit from particular tax advantages set down in legislation. Unlike EMI options, there are no restrictions on the size of company that can use CSOP.
A CSOP option potentially offers an exemption from all income tax and National Insurance Contributions liabilities that would otherwise arise on exercise, so employees will usually be taxed on their gains under the CGT regime. Business Asset Disposal Relief will not typically be available for an employee who acquires their shares via a CSOP and so the gain will usually be taxed at 20%, with the 10% rate only available for lower earners in line with the usual capital gains tax rates payable.
There are also some significant ways in which CSOP options may be considered less attractive than EMI options, explains Kerrie Willis:
- CSOP options can only be granted over a maximum of £60,000 of shares per employee, valued as at the date of grant. EMI options have a significantly more generous £250,000 limit.
- CSOP options will generally only offer tax relief where options are held for a period of at least three years between grant and exercise, whereas for EMI options the relief is available regardless of how long the options have been held. There are some important exemptions for CSOP which mean that in some circumstances CSOP relief will be available when the options have been held for less than three years, e.g. in some ‘good leaver’ circumstances and in some instances where there is a change of control, meaning that, depending on the terms of the transaction, the sale of the company could allow a CSOP option to be exercised within three years and still receive tax relief. The rules in this area are complex, and specialist advice should always be obtained.
- An EMI option can have an exercise price set at any level, although only the gain above the actual market value as at the date of grant will be eligible for tax relief. Importantly a CSOP option must have an exercise price at least equal to the unrestricted market value as at the date of grant in order to qualify. Therefore a robust professional valuation agreed by HMRC, based upon a thorough and complete disclosure of all relevant circumstances, is absolutely critical.
“Changes made to the CSOP rules from 6 April 2023 have made them significantly more attractive. The limit on shares per employee increased from £30,000 to £60,000 but even more significantly the restrictions on the type of shares that could be used in a CSOP have largely been removed, meaning Growth Shares, for example, can now be delivered under a CSOP,” says Kerrie Willis. “Even where the £60,000 limit would be restrictive using ordinary shares, the use of Growth Shares can now enable a CSOP to be useful in many more circumstances.”
Unlike EMI and CSOP, Growth Shares do not benefit from any particular tax advantages set down in the legislation but can still offer a highly attractive tax treatment when structured correctly.
“Growth Shares are a special class of shares created in a company’s articles of association,” says Kerrie Willis. “They can take many different forms, but typically will include a ‘hurdle’ above which the shares participate in the equity value of a company. This hurdle is usually set at or above the current value of the company, which means that the initial value of the shares for tax purposes is relatively low. It can sometimes be prohibitively expensive to award ordinary shares to employees, however Growth Shares can be structured in a way to make this achievable.”
Provided that the Growth Shares are structured the right way, the gain on a future disposal of the shares will typically be subject to CGT for UK residents, resulting in a tax rate of 20% (or 10% for lower earners). A corporation tax deduction is not usually available to employers for any gain realised on the sale of a Growth Share.
“The valuation of Growth Shares is complex, and inadequate valuations of Growth Shares is now a common problem area during the due diligence process before a sale of a company. It is also an area that HMRC’s views on have evolved in recent years, and it is critical that expert advice is taken in this highly specialised area. To neglect this point can result in significant tax charges for both the employee and employer,” says Martin Cooper.
Growth Shares can be a useful structure for companies that also have non-UK employees. As Growth Shares do not rely on any specific exemptions under UK tax law, they are a structure which can produce an attractive tax treatment for employees in many, but not all, jurisdictions.
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“We understand that as your company grows, managing your employee share plans can get complicated, costing you more time and energy. To simplify share plan and equity ownership management, we are delighted to partner with Global Shares, a J.P. Morgan company,” says Martin Cooper. “Our goal at RSM UK is to empower our clients to realise their potential and move forward with confidence. The right employee incentivisation plan is fundamental to helping clients achieve their ambitions.”
To find out more about EMI, CSOP and Growth Shares get in touch, or arrange to speak with one of our equity compensation professionals about what other equity compensation solution might best suit the needs of your company and employees.
Employee ownership, simplified. It’s what we do.
For more information about RSM UK visit www.rsmuk.com