Many small or medium-sized businesses are overlooking a key piece of tax legislation which can enable them to reward key employees, and lock them into the business, in a very tax efficient manner. Simon Littlejohns, Partner and Head of Tax at Birmingham accountants and business advisers Friend Partnership, explains more about Enterprise Management Incentive (EMI) schemes and the benefits.
What is an EMI scheme?
An EMI scheme allows companies, which meet certain criteria, to rewards and incentivise key staff with the award of share options.
An EMI option is great for the employee, giving them a potential capital sum at some point in the future which would suffer tax at a much lower rate than employment income.
Business owners can often be concerned at the prospect of reducing their shareholding percentage in the business. The counter to that concern is that as a result of the incentivised efforts of the employee, the value of the business owner’s shareholding should increase.
Eligibility for EMI schemes
EMI schemes can be put in place by the majority of owner managed businesses.
When exploring the possibility of an EMI scheme, it’s important to consider the following points:
- The shares which are offered must be shares in an independent company or the holding company of a trading group;
- The company must be a trading company (there are certain non-qualifying activities) with gross assets less than £30 million and less than 250 employees;
- The individual employee must work in the company, or a group company, for at least 25 hours per week or 75% of their working time;
- There are limits on the value of the options which can be granted and the limits apply at the company and individual levels;
- There are various other conditions which need to be met none of which are particularly problematic in most circumstances; and
- There are certain prescribed issues which need to be addressed in the EMI scheme documentation.
Benefits of EMI schemes
If the EMI scheme is properly created and implemented, the only tax liability for the individual employee will be when they sell their shares that they acquire as a result of the scheme. This typically will be on a trade sale of the business.
The individual’s tax liability will be at 10% with Entrepreneurs’ Relief, which will be available if the shares are sold more than 12 months after the grant of the option.
HMRC do not need to sign off the rules. The only HMRC input required is the agreement of the value of the shares prior to the grant of the option. In order to secure the tax efficiency mentioned above, the option exercise price must be no less than the market value of the shares under option at the date of grant. In most cases, it is possible to get a low valuation because the shares under option will be a small minority holding with all the usual discounts which apply to any such valuation.
For any business which meets the criteria, and has key staff they wish to retain and incentivise, or indeed wish to recruit with the offer of an equity stake, an EMI share option scheme is an absolute must.
An EMI scheme gives a company considerable flexibility whilst at the same providing the employee with a remarkably tax efficient incentive.