How do EMI options work?

Published on: November 28, 2017 | by: James Farha

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 (HM Revenue & Customs).

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 income.

If an option is fixed at a discounted 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 called being ‘underwater’. In the case of ‘underwater’ shares, 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 within the standard time limits for Self-Assessment.

If options are exercised under the terms of a scheme which is exit-based, 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 deducted via PAYE and not via Self-Assessment.

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