When a business is growing and looking to take on or retain key employees, one of the routes used to obtain “buy-in” is to offer employees the option to receive shares in the company. Employee share options have therefore become a popular route to incentivise staff and can, in certain circumstances, lead to favourable tax treatment.
Before deciding on which route to take you should take both legal and financial (including taxation) advice.
One of the most popular types of option is the enterprise management incentives option (EMI option). EMI options are specifically targeted at smaller and higher-risk trading companies. If an EMI option programme meets the requirements set out by law it may be approved by HMRC and must in any event be registered with them within a 92 day period following the grant of an option). This adds security to the programme and reduces the risk of unexpected tax as long as the requirements are met. The benefits are as follows:
Company
A deduction from corporation tax (CT) can be made in the accounting year in which the option is exercised. The deduction is calculated as being equal to the gain made by the employee. In addition, the Company may seek a CT deduction in respect of the costs of setting up and administering the scheme.
Employee
There is no income tax liability on either the grant or exercise of an option (unless exercise was at a price less than the market value of the shares at the time of the grant, in which case an income tax charge will arise on the difference between the price paid for the shares and the market value at the time of the grant of the option).
Capital gains tax will be payable on the sale of shares acquired through an EMI option if the shares sell at a price higher than the market value of the shares when the option was granted. Subject to satisfying the legal requirements, the shares acquired on the exercise of EMI options will qualify for entrepreneurs’ relief, and the period of time the employee held the EMI option will count towards the 12 month holding period for shares, as required for the entrepreneur’s relief to apply.
As can be seen, there are attractive tax benefits to both company and employee where an EMI option programme is available and, for that reason, they are seen by many as an effective and efficient means of incentivising key individuals.
An EMI option must be offered to employees in writing, and it is recommended that a company has the option tailored to its own requirements. Set out below are the key requirements of an EMI option programme.
Company
- Less than 250 full time employees (or the equivalent);
- Gross assets totalling no more than £30 million; and
- Cannot grant EMI options over more than £3 million worth of shares at any one time.
Employee
- Cannot be;
- A consultant; or
- Non-executive director.
- Must work for the company offering the option for;
- At least 25 hours a week or, if less;
- 75% of their time spent working.
- Cannot have (directly or by an associate) a material interest in the company;
- May only hold up to £250,000 in unexercised EMI options;
- The option must be exercised within 10 years from the date of the grant (or within one year if the employee dies);
Associate
This means a business partner or relative. Relative includes spouse, civil partner, child or other relation in direct ascendance or decadence but does not include brothers or sisters.
Material Interest
A material interest is either;
- The ownership, benefit or ability to control (directly or indirectly) 30% or more of the ordinary share capital of the company; or
- The ownership of or entitlement to rights to receive 30% or more of the available assets of the company upon winding-up or similar.
The above is aimed to be a high level overview and may not apply or be relevant to your specific requirements. Watch out for our more in depth review of the EMI option regime.