The Ultimate Guide to Creating and Forming an HMRC Approved EMI Scheme

Published on: December 14, 2017 | by: James Farha



If you want to learn about the Enterprise Management Incentive (EMI), you’ll find this detailed guide helpful. We’re here to share information about the share option scheme, which provides distinct tax advantages for full-time employees receiving options in the course of their employment. The EMI is designed to benefit companies of smaller sizes. With the EMI, a company will have the capacity to grant options over shares to chosen staff members, which permit these staff members to acquire shares in the company over a set time frame, as long as the selected employees meet qualifying criteria.

With EMI approved options, there isn’t a tax charge at the time the employee is granted the option, as long as the option was given to the employee at market value which is agreed with HMRC in advance of the grant of the option.
Non-EMI approved options given to employees will be chargeable to income tax and a liability for pay as you earn and national insurance contributions will arise.

Under the EMI Scheme, if the price of a firm’s share has gone up between the time of granting the option and the decision to exercise the option, the value of the gain won’t be chargeable to income tax (in most cases this will be in the higher or highest rates of income tax at 40% or 45% respectively (see up to date income tax rates here). Instead, the gain will be subject to chargeable gains tax (CGT) at the lower rates of 20% and 28% respectively (you can see the latest CGT rates here). This charge will be incurred only when the staff member sells his or her shares and the proceeds from that shares sale are greater than the market value which was in place on the date that the option was granted. Further, in certain circumstances, the employee will be eligible for Entrepreneur’s Relief, which reduces the effective rate of tax on lifetime gains up to £10 million to 10%.  As you can see, this type of scheme definitely has tax benefits and this is one of the main reasons why employees love EMI schemes!

Rules For Selling EMI Shares After April 5th, 2012

There isn’t a minimum amount of shares that a staff member has to acquire in order to gain eligibility for Entrepreneur’s Relief. With the EMI setup, the typical one-year holding requirement minimum (for Entrepreneur’s Relief) is altered and it also includes the time period in which the option is held. For example, if an option is held for twelve months, the twelve month holding period is considered to have been met.

This means that holders of EMI share options who exercise their options and sell their shares are considered to be on the same level as shareholders who have had shares for twelve months.

However, there are several ways in which EMI scheme option tax benefits may be lost and it . By informing you of these pitfalls, we’ll help you to avoid them.

If an EMI isn’t implemented according to the terms of legislation, tax advantages may be lost.

If HMRC is not notified about the granting of an option of the EMI type within ninety-two days, the tax benefits of the EMI approved option may be lost.

If an event occurs which is disqualifies the option from eligibility with the requirements of the EMI regime, and the option holder doesn’t exercise his or her options within ninety days, the EMI tax advantages may be lost.

Company directors must be aware of the sorts of circumstances which might disqualify an EMI scheme. It’s easier to avoid these circumstances when they are fully understood. Employees who are eligible should also be educated and we can provide these materials.

How Does This Type of Scheme Function?

A staff member is offered the option to buy ordinary shares in his or her employer’s firm or a subsidiary which qualifies. The cost of the shares is fixed at the time that the option is granted. This information is passed on, to the HMRC.

This option agreement gives the staff member the right to exercise his or her option and buy shares at the fixed price. Usually, this is later on, such as when a staff member has been employed with the company for a particular amount of years, or when the firm is sold to another person or company, or the firm gets listed via a stock exchange.

If the cost of the shares (which are purchased upon exercise of the option) is more or equal to the shares’ market value when the option was granted, no income tax needs to be paid when the option is exercised. This is the primary tax benefit of The Enterprise Management Incentive. Basically, if the company becomes more valuable after the grant is made, the extra value of the shares may be received by the employee who exercised the option, and the uplift in price (profits) will not be taxable as income, but taxable as a chargeable gain, with the possibility of qualifying for Entrepreneur’s Relief.

If an option is fixed at a discount rate, there will be a charge for income tax when the option is exercised. It will be calculated based on the difference between the market value at the time it was granted and the price when the option is exercised. If the market value at the point of exercise is lower than the market value at the point of grant, this means that the options are worth less than they were when they were purchased and this is often known as being “underwater”. In the case of options that are underwater, the tax charge will be calculated based on the value of the shares at the point of exercise.

As long as there aren’t any trading arrangements set up, the staff member won’t need to worry about National Insurance. Instead, he or she will pay taxes due for exercise of the option with the standard time limits for self-assessment.

If options are exercised under the terms of a scheme which is exit-based (i.e. the options can only be exercised on a sale of the company), the agreement for exit will be considered a trading arrangement. This means that, for options which are exercised for lower than the market value at the time of grant, National Insurance will be applied. Tax will be taken out via PAYE and not via Self Assessment.

What About Options for Shares That Are Free?

Let’s explain by using an example. Let’s say Enterprise Management Incentive options were granted in December of 2016, for zero pounds per ordinary share. A share price of one hundred pounds a share is agreed with HMRC (note that we have a 100% track record of agreeing nominal value valuations with HMRC – i.e. agreeing they are essentially valueless even when shares have been sold to investors for tens or hundreds of pounds). In 2019, the firm is sold. At this point, the buyer pays one hundred and fifty pounds per share. In this instance, an employee must pay NICs and income tax on one hundred pounds per share. As well, the staff member will need to pay CGT on fifty pounds per share (that’s the difference between the HMRC share price and the market value of the share upon exercise).

In this case, the net profits for each share are one hundred and three pounds. If we use tax rates for 2017 and 2018, and the staff member is a higher rate tax payer (paying forty percent tax), then he or she will get net profits of one hundred and three pounds for every share. The equation is one hundred and fifty pounds minus income tax of forty percent and NIC of two percent, on one hundred pounds and CGT of ten percent on fifty pounds (the staff member qualifies for Entrepreneur’s Relief). The employer must pay NICs of thirty pounds and eighty pence. That’s thirteen point eight percent of one hundred pounds.

Employers have the right to request that their staff members pay the company’s NICs cost. This decision is made via joint election.

What About Options That Are Offered at Market Value?

Shares at market value are a bit different. Let’s set another example. Let’s say that EMI options were accepted during December of 2016 and the share price was one hundred pounds apiece. The stock price set with HMRC was also one hundred pounds a share. In 2019, the firm is sold on and the buyer pays one hundred and fifty pounds a share.

In this case, the staff member won’t pay income tax or NICs on the award for the share. However, the staff member will need to pay CGT on fifty pounds per ordinary share (one hundred and fifty pounds minus one hundred pounds). The net profits for the staff member are forty-five pounds a share. Let’s assume taxation rates at the 2017/2018 levels. In this case, the staff member will get net cash profits of forty-five pounds per share (one hundred and fifty pounds, minus one hundred pounds, minus CGT, at ten percent on fifty pounds of five pounds).

What are the conditions for EMI Schemes?

Companies may be unquoted or quoted. The firm will need to be independent and not a fifty-one percent subsidiary of another firm, or controlled by another firm (or controlled by a firm and persons linked to the firm). The company will be required to have gross assets of thirty million pounds or less and employ less than two hundred and fifty F/T staff members. As well, the subsidiaries must qualify and the company must have over fifty percent of the ordinary share capital of all firms it acts with. Joint ventures tend to cause complications with qualifying for EMI schemes.

A company must have a permanent establishment in the United Kingdom. It needs to have a set place of business or have an agent who concludes contracts on behalf of the firm.

Also, the company must pass a qualifying trade test. This means that it must exist completely or mostly for the purpose of doing trade, or be getting ready to do so. A trade which is qualifying is a trade which is done mostly in the United Kingdom or in the United Kingdom only. It’s done on a basis which is commercial and it’s about accessing profits which don’t come from a significant portion of activities which are classified as “excluded activities”.

Excluded activities for Enterprise Management Incentive are identical to excluded activities for EIS.

Which Shares Qualify?

Shares for an EMI scheme need to be paid up fully and they must also be ordinary shares of the company which aren’t redeemable. Restrictions linked to the shares need to be reported to option agreement participants or the option agreement must be connected to the company’s articles of association.

Which Staff Members Qualify?

In order to qualify, staff members must be employed at relevant firms for twenty-five hours a week or, if the amount of weekly work hours is lower, for seventy-five percent of the working time of the staff member.

Any employee that indirectly or directly controls more than thirty percent of share capital (for ordinary shares) in the firm may not be granted the EMI option.

Now, we’ve covered most of the rules for The Enterprise Management Incentive (EMI). At this stage, we’d like to let you know the primary stages of putting EMI plans or schemes into place…

How to Set Up an EMI Scheme

  • First, make sure that the company in question and the shares in question do fit the criteria for The Enterprise Management Incentive (EMI).
  • Next, agree activities related to qualifying via HMRC, through the process of advanced assurance.
  • Next, create and agree option terms. These should include conditions for vesting, as well as set restrictions, et cetera.
  • Then, create and agree scheme regulations within the firm.
  • Next, make any changes to articles which are necessary.
  • Make certain that the board approves any amendments to the articles and passes resolutions of the necessary type.
  • Value the firm and agree the valuation via HMRC (this will take into account minority holdings, vesting restrictions and restrictions which relate to shares).
  • Pass resolutions about issuing shares, adopting brand-new articles and approving the terms of the EMI scheme.
  • Grant of option should be exercised, as a deed between firm and staff member.
  • Notify HM Revenue & Customs. For options granted on April 6th, 2014 or after, you may notify via the PAYE portal at the HMRC website.
  • At the end of the year, file the online EMI return via the HMRC online portal.
  • The employee must notify HM Revenue  Customers upon exercise of the option.

Why Choose an EMI Scheme?

Companies use these schemes in order to “incentivize” their managers. When a manager knows that stock options are going to come into play if he or she remains loyal to the company, this may give the manager the incentive to commit to the company over the long term. Without this type of incentive, a manager may start to look around for another employer which does provide stock options (EMIs).

Now that you know more about The Enterprise Management Incentive (EMI) scheme and all that it offers, as well as how to get going with it, you may want to consider offering this type of scheme at your company. While it will take some planning and related tasks, it will definitely give your managers a reason to stay loyal to your company.

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