Enterprise Management Incentive (EMI) share options were introduced for SMEs in 2000, offering companies a great way to attract and retain employees. Rewards received through EMI options are not subject to income tax and National Insurance but instead are taxed as capital gains, which under current tax rules means a tax rate of 20% and in many cases 10%. (See below for more detail on What is EMI?).
All sounds great, right?
But as with any new endeavour, there are some things you need to be mindful of.
So, if you’re thinking of creating an EMI for your company, Postlethwaite Solicitors (specialists in employee ownership and share schemes) highlight 10 common mistakes to watch out for and to avoid….
10 Mistakes to Avoid:
1. Failure to register EMI options correctly
Within 92 days of the date of any grant of EMI options, you’ll need to tell HMRC. Failure to do so will likely mean the EMI tax benefits are not available. We have seen many companies fall foul of this.
2. Option scheme not managed properly / annual returns not completed correctly
Someone capable (within the business or externally) needs to be tasked with managing the option scheme carefully and filing accurate online annual returns with HMRC after the end of each tax year. The annual returns provide data to HMRC which they may use in determining any eventual tax liability for optionholders. And if they’re not filed, or they’re incorrect, HMRC may fine the company. Also potentially expensive remedial work may be needed before options can be exercised or before a due diligence event (eg a new funding round or exit). Worst case is that there’s a dispute over who is entitled to what number of options/shares, and/or the tax advantages of the scheme are lost, resulting in potentially big tax liabilities for the company and staff.
3. Promise to employees not satisfied
If your company doesn’t grow at the rate expected, EMI options won’t deliver the planned level of reward. So when explaining to EMI optionholders how their options work, make sure that in any illustrations of their potential value, it is clear that these are not predictions, just illustrations, and that the value of shares can go down as well as up.
4. No discretion for board on leavers
HMRC doesn’t like EMI schemes where directors can choose whether employees that leave can retain options or not. But what you can do is say a leaver’s options will lapse (or will lapse in certain circumstances e.g. gross misconduct) but reserve the right for the directors to be more generous.
5. Make sure your company and employees are eligible for EMI
Not all companies are eligible to grant EMI options, and not all employees are eligible to receive them. Eligibility can normally be confirmed by completing a short checklist. Re-complete the checklist regularly (because things can change e.g. a fast growing company may reach the maximum 250 employee limit and no longer be eligible to grant further EMI options).
6. Failure to get HMRC approval on the share value
The low tax on EMI options is on any genuine growth in the value of the underlying shares from the date of grant, so if the price at which the shares can be purchased when the options are exercised – the exercise price– is less than their market value at the date of grant, the optionholder will be liable for income tax and potentially also National Insurance on that discount. Certainty that there is no such income taxable discount can be achieved by agreeing with HMRC at the time of the option grant what the shares are worth.
7. Keep a close eye on the financial limits
The maximum aggregate value of a company’s EMI options (measured at the date(s) of grant) is £3 million, and the maximum value for each employee is £250,000. This is another reason why it is important to agree market value with HMRC for each option grant.
8. Restrictions affecting option shares must be clearly spelt out to option holders
There is a requirement that an EMI optionholder be notified in writing of any restrictions affecting their option shares (e.g. limits on how the shares may be sold). These should be summarised in the option agreement. Failure to do so could invalidate the EMI tax status.
9. Locking in option holders after a sale of the company
Company owners often want to stipulate that if the Company is sold, optionholders who then exercise their options and sell their shares to the purchaser may only receive the full sale proceeds if they stay working for the Company for a period afterwards. This is not easy to structure and is generally best avoided.
10. Dealing with uncertain sale value e.g. earnouts
If a Company’s sale involves an earn out and this is applied to optionholders, it may mean that several further years pass before it is clear as to their total reward from their options. At the very least this will create an administrative task and will complicate the optionholder’s tax affairs. Wherever possible if there is to be an earn out it should not apply to optionholders.
We work closely with Postlethwaite’s and others to help you navigate and plan for all these potential hazards when creating and setting up your EMI option scheme. If you would like to discuss any of these issues or would like further legal advice on employee share schemes get in touch on email@example.com
What is EMI?
EMIs are a type of share scheme that can be used for key full time employees and can be a powerful way to encourage your employees to think like owners by acquiring shares in their company, helping to make your business more productive and, profitable and resilient.
However there are certain conditions a company must adhere to, to be eligible for an EMI including;
- Gross (not net) assets of no more than £30m
- Not a subsidiary of or controlled by another company
- Permanent establishment in the UK
- Less than 250 employees
- Shares must be ordinary shares (but don’t need to have all the same rights)
- Within an eligible sector of business