EMI Schemes Explained: How do EMI Schemes Work?
An Enterprise Management Incentive (EMI) share scheme is a government-approved scheme, introduced in 2000, which allows growing companies to attract and/or retain key employees in a tax efficient manner.
The concept of an EMI share scheme is that companies grant the employee share options, i.e. the legal right to purchase a company’s shares within a specified period at a fixed price and subject to various conditions, such as performance or on a sale of the business.
Therefore, if the company’s value increases over time, the employee could realise a substantial profit, thus incentivising them to join/remain with the company.
Recent HMRC statistics show that more than 14,000 companies use an EMI as part of their equity compensation strategy, demonstrating this is a well-trodden and acceptable route for incentivising employees.
Key benefits of an EMI share scheme include:
- Incentivisation and retention of key employees.
- Facilitating succession planning.
- Attracting new staff, pivotally so for start-up companies with limited cash.
- Tax benefits for both employer and employee.
- Flexibility in terms of the design and how it is implemented.
What are the EMI Qualifying Conditions?
There are certain qualifying conditions that must be met by the company for an EMI scheme to be implemented. Broadly, these are:
- The company must not be under the control of another company.
- The company must have gross assets of less than £30m.
- It must have fewer than 250 full-time equivalent employee roles.
- It must undertake a qualifying trade in the UK or be preparing to do so. Take care, there are several excluded trades including banking, providing legal or accounting services, property development, farming and operating hotels or accounting services.
There are also specific qualifying conditions that need to be met by the employee if EMI options are to be granted to them. Broadly, these are:
- The employee cannot own more than 30% of the company whose shares are under option before they have been granted the EMI option.
- The employee is required to spend at least 25 hours per week; or
- 75% of their working time working as an employee for the company.
- The maximum value of shares that can be held under unexercised EMI options by one person is £250,000.
Registering an EMI Scheme with HMRC
HMRC must be informed within 92 days of grant. In order to register an EMI scheme, an employer PAYE reference number is required and, upon registration, HMRC will allocate a scheme reference number within 7 days.
The scheme can be registered via the HMRC Online Service for employers, see here for more information as to the registration requirements.
Annual Reporting Requirements for Employers
Once your EMI scheme is registered, it is important to note that employers are required to submit an Employment Related Securities (ERS) return for each ERS registered scheme (in this case an EMI share scheme) annually until the scheme terminates. The deadline for submission is 6 July at the end of the tax year, with financial penalties for late submissions.
To assuage the additional burdens of ERS reporting, an agent can be authorised to submit your ERS returns for you via the HMRC Online Services for employers.
Finally, upon the dissolution of your EMI scheme, HMRC must be informed (note the authorised agent cannot do this part for you) of the date of cessation via the HMRC Online Services for employers.
EMI Scheme Tax Benefits
For the Employer
- The employing company gets an EMI scheme corporation tax (CT) deduction if qualifying shares are acquired by employees upon the exercise of an EMI option. The CT deduction is equal to the market value when the shares are exercised less the amount the employee paid for them.
- Where EMI options were granted at a discount, CT relief is given for both the amount of the discount and the amount that would have been charged to tax but for the EMI relief.
For the Employee
- Employees are not required to pay income tax or National Insurance Contributions when the share options are granted.
- When the employee exercises their options within 10 years of grant, they will not need to pay income tax if they acquired their options at market value at the date of grant.
However, if the employee acquired their share options at a discount, there will be an income tax charge on exercise which is calculated by taking the lower of
- the market value of shares at grant, and
- the market value of shares at exercise
minus the option price and then multiplying the result by the number of shares purchased. The resulting amount is employment income and is charged to income tax.
Moreover, capital gains tax will be payable when the employee sells their shares. The capital gain is simply the sale proceeds minus the base cost of the shares. The base cost of the shares is the amount actually paid for the shares plus any amount charged to income tax.
Disqualifying Events for an EMI
Often, companies implement EMI share options but then do not ensure they continue to meet the qualifying criteria for relief detailed above. It is important that these criteria are reviewed on a regular basis and that the annual reporting to HMRC is completed to retain the share scheme’s approved status with HMRC. Failure to do so will result in the tax advantaged status of the EMI scheme being lost.
We recommend that a review of the company’s qualifying status is undertaken on a regular basis. Key areas where approval status is often lost include:
- Changes to the qualifying criteria for either the employee or the company or both e.g. the company ceasing to meet the trading activities test or the employee ceasing to be an eligible employee.
- Change of ownership of the company whose shares are under EMI option, excluding when the company comes under the control of a corporate trustee of an Employee Ownership Trust. Note that EMI options can be protected if there is a replacement option in the new parent company.
When a disqualifying event occurs, a participant’s options can be exercised within 90 days and still be treated as EMI options. If exercised within this timeframe, all favourable tax treatments will be retained, such as the employees not needing to pay income tax when exercising their options at the pre-agreed market value.
As such, if, for example, a reorganisation of the company structure is being implemented then it will be critical that advice is obtained to ensure that the EMI share scheme continues to qualify for relief with HMRC.
How can we Help?
It is important that you ensure you have professional tax advice regarding the setting up of an EMI scheme in order to mitigate potential pitfalls.
Here at PD Tax, we understand that many EMI option schemes are bespoke to the company with specific rules and varying performance hurdles. As such we offer guidance relating to:
- The design and implementation of your EMI plan to best suit your requirements whilst maximizing tax benefits.
- The valuation of your company, which is critical in setting the price employees will be required to pay for their shares.
- Ongoing communication regarding reliefs and compliance requirements with HMRC.
Why Choose PD Tax?
A wide range of loyal clients trust PD Tax to deliver the best possible service. Our clients regularly score us according to how likely they are to recommend PD Tax. We are proud of our excellent 30 Net Day Net Promoter Score (NPS) of 100, against an industry average of 43.
If you feel that you may be interested in setting up an EMI share scheme within your own company, please do not hesitate to contact a member of our team. We would be happy to arrange an initial, no obligation conversation to discuss whether this is something that could be appropriate and, if so, what the next steps might be.
“We are more than happy with the service and results we have had over the years, it has been a long and fruitful relationship between us.”
Simon Rowell, Director, Leeds & London Holdings Ltd