Enterprise Management Incentives (“EMI”): the share scheme of choice for small and medium sized enterprises
One of the most successful ways of recruiting, retaining and incentivising staff is through equity participation: share schemes. By allowing employees to own, or potentially own, a stake in the business, a company is able to financially incentivise employees as well as align the interests of its employees with that of its shareholders.
However, in family companies or small private limited companies which form the greater part of all small and medium-sized enterprises (“SMEs”), where control is held by a small number of people, it may not be desirable for employees to actually hold shares in the company.
One of the ways of resolving this conflict is to provide share options to employees. A share option gives the selected employee (the “Participant”) a right to purchase shares in the future, at a fixed price which is determined at the time the option is granted.
The most tax-efficient manner of granting share options is through the use of HM Revenue and Customs (“HMRC”) tax favoured share option schemes. Where the qualifying conditions are met, the share scheme best suited to SME’s is an Enterprise Management Incentive (“EMI”) scheme.
What’s so good about an EMI?
Set out below is a brief description of some of the key benefits of an EMI from the perspective of the Participant and the company:
1. The Participant
Cost: There are no upfront costs to pay on the grant of the option. A cost is only incurred, when the option is exercised. However, exercise will usually be linked to a sale event, in which case any proceeds could be used to fund the cost of exercise.
Risk: Participants are exposed to lower risk than shareholders from fluctuations in share price, as Participants do not have to exercise their option. A Participant would only choose to exercise, when the option was “in the money” (i.e. where the market value of the shares on exercise, is greater than the cost to exercise the option and acquire the shares).
No holding period: Unlike all other HMRC tax favoured share option schemes, the Participant is not required to hold the option for a minimum of 3 years before it can be exercised in a tax efficient manner.
Individual limit: From 6 April 2008, a participant is able to hold an unexercised option (or options) over shares with a maximum total value of £120,000 at the date of grant (the limit was £100,000 up to 5 April 2008). This is considerably higher than any other HMRC favoured share option scheme.
Tax efficiency*: No income tax or employee’s national insurance contributions (“NICs”) liability, when the option is exercised and the shares acquired.
Only when the Participant sells the shares, which were acquired on the exercise of the option, and makes a gain, will a tax charge, to capital gains tax (“CGT”), arise.
From 6 April 2008, CGT will be charged at a flat rate of 18%. Following the Chancellor of the Exchequer’s announcement to the House of Commons on 24 January 2008 an individual may be entitled to be taxed at an effective rate of 10% under the new “Entrepreneur’s relief” on the first £1 million of any lifetime gains where certain conditions are met (i.e. holding at least 5% of the ordinary share capital of a qualifying trading company and having at least 5% of the voting rights).
* This assumes that the EMI option is granted with an exercise price at least equal to market value of the underlying shares and that the EMI option is exercised whilst still a qualifying EMI option.
2. The company
Tax efficiency*: Unlike salary or cash bonus payments there will be no NICs liability for the company when either an option is granted or a Participant exercises an option and acquires the underlying shares.
This provides a potential saving to the company of 12.8% of the value of any financial gain made by a Participant which would otherwise be subject to employer’s NICs as employment related income.
Cost: The costs of providing the shares on exercise of the option are deductible trading expenses for corporation tax purposes.
Minority interests: Until an option is exercised no shares are held by the participant. As a consequence until the option is exercised and the underlying shares acquired, there is no dilution of shareholder rights (i.e. voting and dividend entitlements).
Flexibility: The company can determine how and when options will be exercisable. It is also possible to state different conditions for different Participants.
Ease of implementation: An EMI scheme does not require formal approval from HMRC before options can be granted, it is therefore quicker and less costly to implement than any other HMRC tax favoured scheme.
Certainty: HMRC Shares and Assets Valuation department will agree the “market value” of the shares under option before the option is granted.
* This assumes that the EMI option is granted with an exercise price at least equal to market value of the underlying shares and that the EMI option is exercised whilst still a qualifying EMI option.
If you are interested in implementing an EMI Scheme, or would like to discuss further how it could benefit your business, please contact either Chris Page or Graham Gustard or your usual Vantis contact to arrange a free no obligation initial consultation.
To assist you further we have produced a checklist of some of the key points that you may wish to consider ahead of such a meeting.