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Locking in Human Capital (EMI Scheme)

jon_davageLocking in your key employees is always a balancing act between work life balance, remuneration packages and showing employees they are valued and part of the very fabric of the organisation.

One of the most effective ways of imbedding employees into your business is through capital ownership, which provides a shared goal towards exit and increasing value.

This is a powerful way to tell a key employee of their value to the business and can create an “in this together” attitude.

Such a structure creates rewards for all on a fair basis through the eventual sale of the business.

One of the most popular types of employee share option schemes with SMEs is enterprise management incentives (‘EMI’).

EMI schemes are a popular way of attracting and retaining employees and they can provide significant tax benefits.

Who can grant EMI schemes?

To qualify to grant EMI schemes, a company must be an independent trading company with:

  • Gross assets of no more than £30 million; and
  • Fewer than the equivalent of 250 full-time employees.

There is also a limit on the total value of options that can be granted under EMI of £3 million.

Certain trading activities will not qualify for EMI, for example, dealing in land or shares, or lending money. There are also detailed requirements relating to the shares that can be used for EMI options, such as that they must be fully paid up, ordinary shares.

The company must be an independent trading company, meaning that it must not be a 51% subsidiary of any other company, or otherwise under the control of another company any person connected with it. EMI options are therefore generally granted by stand-alone companies, or the holding companies of trading subsidiaries.

If in doubt, companies can seek advance HMRC clearance that they meet the requirements of the EMI code.

Who can be granted EMI?

EMI can only be granted to employees. They cannot be granted to non-executive directors or consultants.

In order to be eligible, an employee must work for the relevant company for at least 25 hours per week, or if less, 75% of their working time.

Employees cannot be granted EMI if they (or their “associates”) have a “material interest” of more than 30% of the share capital in the company, or in certain related companies.

Tax benefits

There is no liability for income tax on the grant of an EMI option to an employee. Also, provided that the exercise price was not less than the market value of the shares at the date of grant, then there will be no income tax liability on exercise of the option either (however, if the exercise price was less than market value, then income tax would become payable on the difference between the exercise price and the market value at the date of grant). Provided there is no income tax payable, then generally there would also be no national insurance contributions (NIC) liabilities either.

On a sale of the option shares, capital gains tax (CGT) may be payable on any gain over the market value at grant (being the difference between the sales proceeds and the market value of the shares at grant).

Shares acquired on the exercise of EMI will generally qualify for Entrepreneurs’ Relief, provided conditions are met, with the holding period of the option counting towards the 24-month holding period for the shares required for the relief to apply – in which case, the Entrepreneurs’ Relief 10% rate of tax would apply. Otherwise, the standard rate of 10% or 20% will apply depending on whether the employee is a standard or higher rate taxpayer.

What type of shares can be acquired under an EMI option?

As mentioned above, there are detailed requirements relating to the shares that can be used for EMI. EMI must be granted over non-redeemable, fully paid up, ordinary shares. In the case of a group of companies, only the holding company’s shares can be used (due to the reasons discussed above).

A feature which we have recently seen a growth in popularity, is the granting of EMI options over “growth” shares. These are typically a separate class of ordinary shares in a company, under which the holder would only share in the capital “growth” in value of the company over a specified “hurdle”. For example, if the value of the company at the date of the grant of the option was £2 million, then the capital rights attaching to the shares would only entitle the holder of the relevant shares to participate in any value, such as exit proceeds, over £2 million (and not to participate in the first £2 million).

How can Bermans assist?

If you would like to discuss the benefits of implementing an EMI scheme, we would be happy to discuss it further with you. Bermans can assist in all aspects of this, including:

  • Drafting the scheme rules which will set out the main terms on which EMI options can be granted and ensure that they comply with the detailed statutory requirements.
  •  Preparing the option deeds which will be issued to the individual employees.
  •  Preparing articles of association for the company to adopt if, for example, a new class of shares needs to be created, or if particular “restrictions” are needed for the shares, such as restrictions on transferring them or “drag-along” provisions.
  •  Drafting the mechanical documents to grant the options, such as board and shareholder resolutions.
  • As EMI is intended to be a tax-efficient way of incentivising employees, we would always recommend seeking the advice of an accountant or tax specialist prior to implementing the scheme.

For example, it is always best to agree with HMRC that the company meets the requirements to qualify for EMI, and also to obtain a pre-agreed valuation with HMRC on the value of the shares over which options are to be granted.

Bermans has a lot of experience in both the technical and strategic side of employee incentive schemes and would work in tandem with your accountant in putting the scheme in place.

We work with a number of reputable accountants and tax advisers who regularly advise on EMI schemes, so would be happy to put you in touch.