I find myself answering questions on EMI (Enterprise Management Incentive) share schemes fairly regularly.
It’s common for business owners to look into these schemes for a variety of reasons (which I’ll get into later) like:
- Reducing their tax burden
- Increasing employee retention rate
- Rewarding key employees
So, I decided to write a short explainer on the subject detailing the options, benefits and drawbacks, and possible implementation strategies when it comes to EMI share schemes.
EMI share schemes in simple terms
An EMI share scheme is a tax-efficient programme where employees are granted the right to purchase company shares at an agreed price (typically the price at the time the options are first granted).
In this way, option holders may benefit from future growth in the value of the business, thus aligning the employee’s interests with the business's success.
To benefit from the special tax status afforded to EMI schemes, HM Revenue & Customs must be notified when options are granted, and the scheme is only available where certain conditions are met by the company and by the option holders – both at the time of grant and subsequently.
The role of EMI schemes in incentivising employees
The whole point of EMI share schemes is to motivate and reward employees for their contributions to the company's success.
Rather than just being workers in a company, your employees get a sense of ownership which, of course, boosts commitment to the common cause.
This increased dedication should hopefully mean improved performance and a stronger bond between employees and the company.
How do EMI share schemes work?
First and foremost, the company grants eligible employees the option to purchase shares at a predetermined price, known as the exercise price.
These options are typically subject to certain conditions, such as a vesting period or performance targets.
Employees are not obliged to exercise their options but can choose to do so when they believe it's advantageous (and provided the options have vested and any performance conditions have been met).
When employees do decide to exercise their EMI share options, they typically notify the company and provide the necessary funds to purchase the shares at the exercise price.
Once exercised, employees become shareholders with all the associated rights, including the potential for dividends and voting rights.
The specific process may vary depending on the company's EMI scheme rules and procedures, but this is just a general guide.
Do they reduce your taxes?
There are tax advantages for the employee and also, potentially, for the company.
No tax on grant of options: When a company grants EMI share options to its employees, there is generally no immediate tax liability for the employees.
This means that they do not incur Income Tax or National Insurance Contributions (NICs) at the time the options are granted.
This initial tax efficiency allows employees to receive the potential benefits of share ownership without an upfront tax burden.
If, instead, a higher wage was offered, they would potentially be paying considerably more Income Tax.
No tax on exercise: Provided that the exercise price is at least equal to the market value of the shares at the time the options were first granted, there is normally no Income Tax or NIC on exercise of the options, either.
Capital Gains Tax on sale: If and when the employees subsequently sell their shares, any gain on disposal is likely to be subject to Capital Gains Tax (CGT).
CGT rates are typically lower than Income Tax rates (both in Scotland and England), and individuals also have an annual tax-free allowance for CGT known as the Annual Exempt Amount, which allows them to shield a small portion of their gains from taxation.
In some circumstances Business Asset Disposal Relief (BADR) may also be available, reducing the CGT rate to 10 per cent on up to £1m of lifetime gains.
In short, EMIs reduce employees' taxes by deferring their tax liability until they exercise their options and sell the shares, typically subjecting them to more favourable CGT rates instead of immediate Income Tax and NICs.
Corporation tax: When options are exercised, the company is usually able to claim a deduction against profits based on the difference between the market value of the shares at the time the options are exercised and the amount the employee actually pays for them.
Is your business eligible for an EMI?
For a company to implement an EMI share scheme, it must meet specific eligibility criteria.
These criteria include being an independent trading company (or holding company of a trading group) with a permanent establishment in the UK and having gross assets below £30 million.
Also, its activities must not fall under certain excluded sectors, such as investment, property development, ship building or farming.
Other benefits of EMI share schemes beyond tax efficiency
I always advise my clients that they need to look at the wider picture when it comes to this issue.
Firstly, they could provide you (if you’re not the business owner) with the opportunity to acquire shares in the company, potentially leading to financial gains if the company's value increases.
From an employer's perspective, EMI schemes can also be a powerful tool for attracting and retaining top talent.
Offering your employees a chance to become shareholders has multiple benefits.
- A boost to employee morale
- An increased sense of loyalty
- It serves as an attractive benefit for talented individuals looking for work
On top of this, when employees have a direct stake in the company's performance, they are more likely to go the extra mile, work towards long-term goals, and contribute creatively to the company's growth.
Essentially, the sense of ownership and shared success can lead to a more engaged and dedicated workforce.
Do employees risk Capital Gains Tax implications when they sell their shares?
(While I recommend EMIs to many clients, I also suggest they educate their employees on this issue before they enrol).
CGT rates are generally lower than Income Tax rates, especially for long-term investments.
This makes EMI share options an attractive way for employees to benefit from potential share price appreciation with a favourable tax treatment upon disposal.
Income Tax for an individual earning £60,000 in Scotland is currently 42 per cent (40 per cent in England) whereas the CGT rate for someone on the same income is no more than 20 per cent (for both countries) and may be only 10 per cent where BADR applies.
What can go wrong with EMI schemes?
Failing to effectively communicate the details to employees can result in employees not appreciating the value of the scheme or misunderstanding their rights and obligations under it. A poor take-up is never a good thing.
Similarly, if an EMI scheme is overly complex, it can become difficult for both employers and employees to understand and manage it.
This complexity can deter employee participation and lead to administrative challenges, reducing the effectiveness of the scheme as a motivational tool.
Equally, determining the right amount of equity to offer is also very important.
Offering too much equity can dilute the ownership stake of existing shareholders, while offering too little may not provide sufficient incentive for your employees.
Finally, inadvertently breaching compliance, such as failing to adhere to the rules regarding qualifying employees or the nature of the business, can result in significant tax implications and legal issues for both the employer and the employees.
Should you implement an EMI share programme?
Whether or not you decide that EMI share schemes are going to work for you and your business should always be discussed with an accountant who is qualified and experienced in these things.
Scholes CA frequently helps clients to establish and implement EMI schemes.
I remember one instance where we used an EMI to boost the incomes and benefits of individuals working in the renewable energy sector.
(You can read more about that scheme here).
So, if you’re interested in developing your own EMI policy, discuss it with one of our team first.
Please reach out by emailing me personally: at ivan.houston@scholesca.co.uk or by calling your local Scholes CA branch.
