EMI was introduced in 2000 to encourage employees to own shares in their employing company or, if a group of companies, in the parent company. It is commonly used as a means of rewarding, incentivising or retaining employees or for a combination of these objectives.
The options can be awarded with certain conditions which must be achieved before the option vests and the employee is entitled to exercise the option. These objectives can be aligned to the business objectives and can set goals specific to each employee, ensuring the employee focuses on the key business drivers.
The company has to satisfy qualifying conditions including regarding the nature of its trade. There are also size criteria that need to be satisfied: the gross assets cannot exceed £30m and the full-time equivalent number of employees cannot exceed 250.
What is an EMI?
An EMI, which is commonly used by small listed and privately held companies, is a tax- advantaged share option plan designed to encourage employees to own shares in their employing company and to participate in the growth of the company. The employee can at any time hold options over shares to the value of £250,000. The total value of unexercised EMI options (valued at the date of grant) that a company can issue is £3m.
Why use an EMI?
The main benefit of the plan is that employees can acquire shares in the company without incurring an income tax liability and can participate in the increased value of shares at capital gains tax rates. In addition, neither the award of the options or the exercise of the options gives rise to a national insurance liability, which is advantageous to both the employee and the company.
Employees value both the tax-efficient nature of the plan and the opportunity to participate in the growth of the company which in turn can have a positive impact on motivation and retention.
How does an EMI work?
The employee is awarded options over shares in the employing company (or if a group in the parent company). The option deed will specify what conditions must be satisfied before the option will vest and will set out the earliest date on which the options may be exercised. The options must be capable of exercise within 10 years.
When the conditions are satisfied, the employee can exercise the option paying the agreed price (if any). The employee then owns the shares and will be subject to capital gains tax when the shares are sold.
The exercise price can be granted at less than the market value of the shares at the date options granted but this will affect the income tax position, see below.
Under both UK GAAP (current and FRS 102) and IFRS the grant of an EMI option will be regarded as a share-based payment arrangement, with the detailed accounting treatment being determined by reference to the terms of the plan.
Share-based payment arrangements can be either ‘equity-settled’ or ‘cash-settled’.
When the EMI is accounted for as an equity-settled arrangement, the charge to the profit and loss account is calculated by reference to the fair value of the options at grant date determined using an appropriate financial model. The period over which the charge is made will be determined by the terms of the arrangement. When the EMI is accounted for as cash-settled, the fair value of the future liability is re-measured at each reporting date and again at settlement. Advice should be sought as it is not always certain which accounting method will apply and this may vary between the group and subsidiary level.
The charge will be adjusted in each year to take account of the company’s expectation of the number of options that will ultimately vest.
In circumstances where an employee benefit trust is used to facilitate the arrangement, although the shares will be held in a separate trust, both UK GAAP (current and FRS 102) and IFRS require that the shares are reflected in the accounts of the company.
The employer will usually qualify for a corporation tax deduction when the employee exercises the options equal to the difference between the exercise price and the market value of the shares on exercise.
Income tax and NIC
No income tax or national insurance liability arises on the grant of the option.
Where the exercise price is at least equal to the market value of the shares at the date of grant, no income tax arises on the exercise of the option if exercised in a qualifying manner.
If the options have been granted at a discount to market value at the time, there is an income tax charge on exercise based on the lower of the market value at grant or at exercise less the exercise price and any amounts paid by the employees for the grant of the option.
If a disqualifying event occurs, the option holder has 90 days to exercise to retain the tax benefits. Otherwise, an income tax charge will arise based on the increase in market value from the date of the disqualifying event.
For companies that are listed, or where there is a market for the shares, any income tax arising from a disqualifying event will be collected through PAYE and there will also be a national insurance liability.
Capital gains tax
A capital gains tax liability may arise when the employee disposes of the shares. The chargeable gain will be based on the sale proceeds less the price paid to exercise the option and the amount on which any income tax liability arose on exercise, subject to the special rules for share cost ‘pooling’ where the employee also holds other company shares.
Entrepreneurs’ relief (ER), resulting in a tax rate of 10%, on EMI share disposals by an employee made on or after 6 April 2013 no longer requires a minimum 5% shareholding, provided the option was granted at least 12 months before the disposal date. The 12 month holding period required for ER runs from the date of grant, and not the date of exercise.
For whom is an EMI suitable?
The use of an EMI is particularly attractive to the types of employers set out below.
Companies seeking to align the employees’ interests with those of the company and other shareholders to ensure growth.
Companies looking to lock-in key employees in the medium term.
Companies seeking to encourage share ownership through tax efficient share acquisition and enabling employees access to ER on their share ownership.