Everything You Need to Know About the EMI Scheme
An Enterprise Management Incentive, or EMI, is a government backed initiative designed to provide tax advantages to businesses like yours. Here’s everything you need to know.
EMIs are a share options scheme that allow businesses to give options to employees in the most tax efficient way possible.
EMI schemes are great as they arm businesses with the ability to reward employees while offsetting costs against the company’s tax bills. So, an EMI should be the de facto choice if you’re interested in share options. That is, providing your business meets certain conditions.
EMI schemes are also tax efficient for recipients, who pay just 10% Capital Gains Tax on the gains. Around 15,000 UK startups use EMI schemes, but uptake remains relatively low among eligible businesses.
This is a guide to everything you need to know about the EMI scheme.
What is the Enterprise Management Incentive (EMI)?
To understand EMI, it's first important to understand what a share option is.
A share option is a right to acquire shares in a company on terms set out in an option agreement. This will specify how many shares an employee may acquire, how much he or she will have to pay for the shares, and when the shares can be acquired through the exercise of the option.
Option exercise may take place, for example, after a set period of employment, on the achievement of performance targets, or upon the sale of the company.
EMI schemes are tax advantageous share option schemes. They were first set up in 2000 and have become the most widely used HMRC backed incentive arrangement.
Offering ownership is a tried and tested route to attracting top talent and retaining them, and it’s become relatively standard across startups. Data shows that almost half of startups put aside some of their equity at funding for share options.
The benefits of EMI schemes
EMI schemes are flexible like other share schemes, But they’re also designed to be tax efficient to help you grow in those early days.
For an EMI scheme, tax is only incurred on the value of schemes when they're awarded and not at the point they’re exercised. This is the biggest tax difference between EMI schemes and other schemes - and can amount to a major windfall.
Capital Gains Tax is applied at a lower rate of 10% instead of 20% so long as the shares aren’t sold within 24 months of the option grant.
Benefits of EMI schemes for employers:
Corporation tax relief on the difference between the market value of shares at exercise of the options (a key benefit - can provide significant boosts to the business/shareholders on a sale)
No employer’s National Insurance Contributions (NIC)
No tax cost
Benefits of EMI schemes for employees:
10% (vs 20%) Capital Gains Tax ) on the growth in the value of shares.
Lower tax costs than cash or other non-EMI arrangements
No income tax and no employees’ NIC on the grant or exercise of the options
All of the above are subject to certain criteria, which is why properly organising the EMI scheme with specialist support is so important.
EMI schemes provide benefits beyond tax relief
Offering ownership to new employees is proven to boost engagement and retention, it’s a great way to locate top talent.
1: Attracting top talent
In today’s hypercompetitive job and labour market, providing benefits beyond a salary is necessary to locate and attract top talent.
Ownership can be combined with a lower salary - a feature that’s ideal when working with a tight short term budget but excellent future prospects.
EMI schemes are a long game. To see significant returns, employees will likely need to stick around - and they will, as long as the business grows.
This is exceptionally useful for employing key team members and reducing business downtime relating to job vacancies.
The cost of losing and rehiring someone can be as high as £15,000 - a cost worth swerving!
3: Engaging employees
Studies show that engagement increases when employees own shares and have excellent growth potential.
Employee engagement is a massive growth driver. And, of course, the benefits of an EMI scheme are genuine, as they can lead to a massive windfall for employees if things go well, and no risk if things don’t progress as expected.
Should employees have EMI share options or shares?
There is no certain answer to this. In some cases, it will make sense for employees to have shares from the outset. However, this will generally involve employees having to pay for their shares, or suffering a tax charge if their shares are gifted or bought at less than full value.
Having share options can provide more of an incentive than having shares if the options are only exercisable upon achieving targets.
And many prefer employees not to have shares from the outset, because of complications if employees leave. So, more often than not, the preferred solution is share options rather than upfront shares.
EMI schemes might seem confusing, but once they’re well worth the initial strain.
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Unapproved options vs EMI schemes
When you compare EMI schemes to other share options schemes, it’s pretty clear they’re the most tax efficient option, providing businesses and employees meet all criteria.
With EMI schemes, tax is only incurred on the value of schemes when they're awarded rather than when they’re exercised. This is the biggest difference between EMI schemes and other schemes.
Capital Gains Tax is applied at a lower rate of 10% instead of 20%.
Remember, the shares cannot be sold within 24 months of the option grant for this discount to apply.
Unapproved options vs EMI schemes case studies
Let’s put this into perspective. Meet John.
John is granted an unapproved option to acquire a 3% shareholding in his employer company for its market value of £10,000. Four years later, he exercises the option at a time when the shares are worth £100,000, and two years after that, he sells them for £150,000 when the company is taken over.
John pays no tax when the option is granted, but on exercise, he’s treated as having received taxable earnings of £90,000 (£100,000 share value less £10,000 option exercise price).
As a result, he pays income tax at his marginal income tax rate, tax of up to £40,500, even though, at this stage, he has received no cash.
On the sale of the shares, John pays capital gains tax on the £50,000 growth in value since he acquired the shares. Ignoring any reliefs he may have available, tax is charged at a rate of 20%, tax of £10,000.
So although John has been very fortunate in being able to acquire shares for £10,000 and sell for £150,000, BUT he has had to pay a tax of up to £50,500. Most of which is payable well before he has received any money (and which might have been lost altogether had the shares collapsed in value).
EMI scheme tax impact
Next up, meet Jane.
Jane is granted an EMI option to acquire a 3% shareholding in her employer company for its market value of £10,000. As in the previous example, four years later, she exercises the option when the shares are worth £100,000, eventually selling them for £150,000 when the company is taken over.
Jane pays no tax when the option is granted, and nor does she pay any tax when the option is exercised.
On sale of the shares, Jane pays capital gains tax on the gain of £140,000 (£150,000 sale proceeds less £10,000 option exercise price). Ignoring any reliefs she may have available, tax is charged at a rate of 10%, tax of £14,000.
So Jane has saved tax of approximately £40,000 as compared to John and paid no tax at all until after receiving her share sale proceeds. EMI tax treatment has been a big advantage for Jane.
So, how did EMI options make a difference here?
In the above example, there are two main tax benefits:
First, no income tax is usually charged upon the exercise of the option
Second, capital gains tax upon eventual sale is usually set at a reduced rate of 10%
Who can receive EMI options?
EMI options can only be granted to a qualifying employee of a qualifying company.
The company has the discretion to decide which employees should have options, up to a maximum share value of £250,000 per employee, £3 million for the whole company.
Employees (including directors) qualify if they’re engaged to work at least 25 hours per week for their company or group or, if less, for at least 75% of their working time. So a part time employee can qualify by working, say, two days a week for the company. That is, provided that work elsewhere does not amount to more than 25% of the whole.
Most tech startups will likely qualify. A qualifying company or group must be independent, i.e. not controlled by another company.
At the date of option grant, gross assets must not be higher than £30 million, and they must have fewer than 250 employees or full time equivalents.
The company or group must carry on a trade and can’t to a substantial extent, carry on excluded activities. These are non trading activities like property investment and a number of trades, including property, banking, insurance, professional services, leasing and hotels/care homes.
Must be actively trading and have permanent premises in the UK
Cannot allocate more than £3 million in EMI shares
Must have fewer than 250 employees when the EMI options are granted
Can’t be a subsidiary or externally controlled
Total assets under £30 million
Can’t hold more than 30% of all company shares
Must be legally employed
Must be contracted for 25 hours per week, or 75% of their working time must be as an employee or director of the company (this stops employees from working multiple EMI schemes)
How does EMI work in practice?
Working with professional advisers, you need to start by figuring out whether you’re EMI qualifying. If you are, your next steps should be to decide how your EMI scheme plan is to work.
EMI is very flexible, but key issues include:
Which employees should be granted options, and over how many shares
When should options be exercisable, for example, should exercise be based on performance targets or occur only when the company is sold
What type of shares should be subject to options, for example, should they be ordinary shares or a special share class designed for options, perhaps non voting shares
How much employees have to pay to exercise options and acquire their shares
What happens if an option holder leaves the company
Once these issues are decided, you should prepare formal EMI option agreements to record all the relevant terms. Once signed by all, the options are formally granted.
Option grant must be notified to HM Revenue & Customs within 92 days.
Once you’ve established eligibility for an EMI scheme, you must file a valuation with HMRC. This is valid for 90 days. Once agreed, the share pool is authorised and approved by the board and shareholders (if applicable).
Businesses must tell HMRC about a grant of an EMI share option by notifying them within 92 days of the date of the grant. Otherwise, they risk losing the tax benefits.
When a business grants EMI options, they’re normally made available according to a vesting schedule. This allows employees to slowly gain ownership rights. The vesting schedule dictates when the shareholder has the right to exercise the options.
Under an EMI scheme, the employee can exercise options upon exit (e.g. when the company is sold) or completion of a specified vesting schedule.
Vesting schedules are popularly time based on performance. Time based schedules incentivise employees to stay and see their shares vest over a certain period, e.g. monthly or annually. Performance based vesting schedules are commonly set by:
Annual Recurring Revenue (ARR) increasing
Company valuation reaching a threshold(s)
Monthly Recurring Revenue (MRR) increasing
Customer acquisition goals
To sum up
EMI options are a proven incentive for employees, and companies that offer them are in an excellent position to attract top talent and retain them as the business grows.
If your company has yet to implement an option plan, maybe now is the time to consider it.
While it might seem complex to implement, once the EMI scheme is in case, it’s relatively straightforward to maintain.
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