It’s not just the likes of Google, Facebook, and Amazon that offer shares to employees. It happens here in Britain too under something called the Enterprise Management Incentive (EMI) scheme.
The long-term business benefits of employee share ownership have been proven as they:
- encourage staff to stay with a company and go that extra mile in helping that business develop, and
- give the opportunity for committed staff to share the benefits in any later trade sale, initial public offering, or round of investment.
If you run a business and are interested in the EMI scheme, here’s the very latest information on it.
Who can I offer the EMI scheme to?
Which staff members qualify? Those who either:
- work 25 hours a week or more for you, or
- whose time working for you is at least 75% of your working day
You can grant them up to £250,000 worth of share options a year.
Wise Accountant note – when you “grant” share options, that’s the time when you award them. Those shares can be “vested” or exercised at a later date.
Wise Accountant note – HMRC will likely not grant an EMI scheme the approval it requires if it believes that the arrangement is being made to avoid tax.
What is a share option?
An EMI share option gives your employee the right to buy the shares at a later date for an agreed price.
If your business is valued at £1m, you might want to give your employee the chance to hold 1% of the total shares. The value of those shares would be worth £10,000. That £10,000 worth of share options might be made up of 100 shares priced at £100 each. You want your staff member to hold onto their share options for five years before they can “vest” them.
Let’s say your company has a brilliant 5 years and you grow the value of your business from £1,000,000 to £4,000,000. Your employee’s share options are now worth £40,000 but their share option allows them to buy these £40,000 worth of shares for £10,000. Each individual share has increased in value from £100 to £400.
Are there conditions surrounding an EMI scheme?
The shares under option must be part of the ordinary share capital of your company. Each share option must be fully-paid up and not redeemable.
At any given time, the value of the unvested share options must not be greater than £3m.
Also, there is a time limit of 10 years between the granting and vesting of share options so that your employee gains the full tax benefit.
Deciding on a company valuation
The value of a business is always difficult to judge, whether it’s for EMI scheme purposes or you’re putting your company up for sale.
HMRC will always have their own opinion so it’s best to get them and other independent experts involved in the process.
When you’re valuing your company, use professionals like your accountants and always get them to show the methodology they’ve used when coming up with the price.
The more independently verified and thoroughly calculated, the better. If you have solid figures to operate on such as a recent offer to purchase your business or someone has put in a round of investment for a stake in your company, those are very valid metrics you can employ in deciding on the actual value of your firm.
How does tax and EMI work?
How tax works depends on the EMI scheme you’ve offered to your staff.
Many employers give share options away free of charge to their staff members. Using the example of the company above worth £1,000,000 at time of grant and £4,000,000 at the time of vesting, the value of their shares at vesting is £40,000 and their original share option of £10,000 was given to them free.
This is how the tax would work for them:
- your employee pays income tax and Employee’s National Insurance on each £100 share.
- they will pay capital gains tax at the Entrepreneurs’ Relief rate of 10% on £300 a share (today’s price of £400 minus the original £100 price)
For higher rate taxpayers, their shares would be worth £328 each.
That’s £400 minus £40 income tax (40%) and £2 National Insurance (2%) on the original £100 price. That leaves the employee with £358 per share. They pay an additional £30 per share in Capital Gains Tax at Entrepreneurs’ Relief level, leaving each share worth £328 after tax.
Your company would be liable to pay National Insurance Employers’ Contributions at 13.8% of the original £10,000 value, a cost of 13.8%. It is not unusual in these agreements to ask the employee to bear this cost.
What if you charged for the full value of those £10,000 worth of shares when they are vested?
- Your employee pays no tax or National Insurance Employees’ Contributions on the £10,000
- Your employee pays capital gains tax at the Entrepreneurs’ Relief rate of 10% on the £300 increase in value per share.
After the deduction of tax, they make £270 per share after tax.
If, by the time shares are vested, they are below the value of the time they were granted, employees will pay tax based upon the market value at the time of vesting.
EMI scheme qualification criteria
Your company must be independent in that it controls 51% or more of its shares and be based in the UK.
You can’t have any more than 250 staff and your net liabilities sheet can’t show more than positive £30m in its gross assets column.
There are certain restricted trades that don’t qualify for the EMI scheme, including:
- land investors
- share investors
- financial services companies
- asset leasing
- royalties or licence fees recipients
- legal services
- accountancy-related services
- property developers
Setting up an EMI scheme for your company
Your company can grant options on its shares to employees at any time.
First, you need to decide which employees you want to be included in the scheme and the number of share options granted to each staff member.
Second, you need to think about the structure and the design of the scheme, specifically when the shares can be “vested” – that point in time when the employee actually exercises their options to buy the shares. Will it be straight away, a percentage after a defined number of years, or an exit event, like a sale or an investment round?
Third, what the price of the options are going to be to your employees and what is the basis for the valuation you are giving your company?
There is no need to seek the prior approval of HMRC on EMI schemes – you just simply need to notify HMRC within 92 days after an option has been granted.
We do however recommended you work with HMRC. The EMI scheme has been in place since 2000 and enjoys widespread support politically so there is a strong operational motivation for HMRC to help you while you are setting the scheme up and particularly during valuation.
You will need to change your company’s Articles and pass the necessary resolutions at board meetings to enable the scheme. The new Articles and the resolution will need to be filed at Companies House.
At the end of each year, you will need to complete your EMI return on HMRC’s online portal and your employees will have to individually notify the taxman about their participation in the scheme
EMI scheme disqualifications
The income tax and National Insurance elements of the scheme are lost incrementally if a share option is not vested within 90 days of what HMRC call a “disqualifying event”.
Tax and NI will be charged on the monetary amount that HMRC deems to be applicable if the market value of the shares at the date of vesting is higher than the market value before the disqualifying event.
The income tax charge is based upon the growth in value after the event. If the share option is granted free to the employee or at a discounted rate, income tax will be an added to the charge on the discount at applicable rate.
What are disqualifying events?
- the company comes under the control of another company
- the company comes under the control of another company or any person connected with that company
- the company begins to trade in areas that are restricted (see above)
- the employee holding the share option ceases to be an employee
- an employee’s working hours are reduced to less than the qualifying working hours
- there are changes to the terms of the option
- the company’s share capital structure is changed
- the company’s shares are converted
- a new wave of share options means that an option holder now has over £250,000 worth of share options
- enough shareholder leave so that an EMI option holder has more than 30% of the company’s share capital
- if another company invests and it fails the independence test
- a change is made to a company’s articles allowing others to take control of the company if certain financial or operational performance levels are not met