EMI Share Scheme & Tax Benefits
Some companies offer shares, or the opportunity to acquire shares, in the company to employees as part of their remuneration package. To do this, companies will have to set up a share scheme, but they can use either approved or unapproved schemes. Approved schemes are ones which offer HMRC-authorised tax benefits, whereas unapproved schemes do not.
What is an EMI scheme?
The Enterprise Management Incentive (EMI) is one type of HMRC-approved share scheme that can be used by small to medium sized companies. Growing entrepreneurial firms may choose to offer EMI shares in order to recruit and retain highly talented and skilled employees where they cannot match competitive salaries. The intention is that, by offering the opportunity to have a share in ownership of the business, it encourages employees’ goals to align with the growth of the business. EMI schemes are particularly popular due to the flexibility and tax benefits available for both employees and the company.
How does an EMI Scheme work?
A company will offer an employee either shares or a share option in the company. The value of the shares will be fixed at the market value at the time the share agreement has been created and offered to the employee. The market value needs to be approved by HMRC which is done through completing a VAL231 form.
If the employee is offered a share option, they can choose to take up the offer of purchasing the shares and this is referred to as ‘exercising the option’. Exercising a share option will often be done at a later date as usually conditions will be attached that the employee must meet in order to become eligible. Examples of common conditions set by companies include a minimum time requirement that the employee must be working at the company for or meeting a certain target before being able to exercise their option and receive shares.
If the employee chooses to exercise their share option and they pay the fixed market value agreed at the time of option grant, then they will not have to pay income tax or national insurance (NI). In the ideal situation, the employee will choose to receive shares when they are worth much more than the initial market value and yet would only have to pay the fixed market value rate that was set at the time of option grant.
However, if the employee pays under the market value or is given the shares for free then they may need to pay income tax and NI on the difference. Where the shares acquired are readily convertible assets, tax is accounted for under PAYE and NI is due. If the shares are not readily convertible assets, tax is charged under Self-Assessment and no NI is due. Broadly, readily convertible assets are shares that can be sold on a recognised stock exchange or for which trading arrangements are in place, or are likely to be put in place, at the time when the shares are acquired.
Where the employee chooses to sell the shares, they may be eligible to receive the tax benefit of paying a lower rate of capital gains tax (if a gain has been made and the amount exceeds their capital gains tax allowance). Shares are an asset that are usually charged tax at 20% for higher rate and additional rate income taxpayers, but EMI shares may qualify for Entrepreneurs’ Relief (ER) which is charged at 10%. To be eligible for ER, the employee must still be employed at the company and must have been granted a minimum of 24 months before the shares are sold.
The company also benefits when an employee exercises their share option if the shares are worth more than the original fixed price. The difference in value can be claimed against the company’s corporation tax as it is seen as an expense to the company.
What are the advantages of an EMI scheme?
An EMI scheme is popular not only because of the tax benefits it offers to both employees and the company, but also because of the flexibility it offers to the business owners. Unlike some other approved share schemes, EMI shares or share options do not have to be offered to every employee in the business. Also, with EMI share options, there is no minimum holding period which means shares can be granted immediately if a company would like to do so. Finally, the maximum value of shares that can be offered to employees is much higher than other schemes which is why it is particularly useful for attracting and retaining employees.
The EMI tax benefits for employees:
- No income tax or National Insurance to pay when shares have been granted
- Reduced capital gains tax rate of 10% on profits made when shares are disposed of
The EMI tax benefits for the company:
- The difference between the price of the shares that an employee pays and the actual value of the shares at the time of exercise is an allowable deductible expense for corporation tax purposes
What are the disadvantages of an EMI scheme?
The disadvantages of an EMI scheme are the strict eligibility requirements which need to be adhered to. As such, most of the disadvantages are common pitfalls that easily invalidate the scheme or the tax benefits. Here are the top risks that companies should look out for:
- Companies must pace growth, and those that grow too quickly where they exceed the £30 million asset limit or hire over 249 employees will find themselves no longer eligible
- Companies must be careful when making organisational changes such as creating a holding company which is placed on top as this may mean the company becomes controlled by another entity
- Where a disqualifying event occurs (an event that means the company or employee is no longer eligible), the share option much be exercised within 90 days or they become unauthorised shares with no tax benefits. This means there are tight deadlines to ensure the EMI benefits remain available.
- EMI shares must be sold to employees for cash at the market value price agreed at the time of scheme set up. If they are given to employees or sold to them for a lower price, they will lose some of the tax benefit and face income tax and national insurance contributions.
- As of April 2019, employees must hold onto their shares (not the share option) for a minimum of 24 months before disposal in order to be eligible to receive the discounted capital gains tax rate of 10%. Not everyone is aware of this as it is a relatively new change so companies must keep their employees informed.
How to set up an EMI share scheme
In order to be able to run an EMI scheme, both the company and the employee need to meet eligibility criteria. The company will then need to determine various terms of the scheme before registering it with HMRC. Although every EMI scheme is different and will be created to suit the individual company, the main purpose for creation and use should be to recruit and retain employees.
You can find more information and help on our article ‘How to set up an EMI share scheme’ for further instructions.