Share options – enterprise management incentives




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NOTE: This document does not provide legal advice – it is only intended as a discussion draft to be updated and modified to fit the circumstances. The publishers and authors shall not be liable to any person with respect to any loss or damages caused or alleged to be caused directly or indirectly by the information or any mistake in this document. In particular, all statutory references should be checked and users are reminded that changes are continually being made to the law and the document will not be up to date. [25 August 2011]

LEGAL GUIDE


SHARE OPTIONS – ENTERPRISE

MANAGEMENT INCENTIVES

The Enterprise Management Incentives (EMI) share scheme is intended to assist smaller high risk companies by enabling them to grant tax efficient share options as a means to incentivise high calibre employees. Prior to EMI companies wishing to use share options as a means to recruit and retain employees without offering high salaries had either to suffer the consequences of potentially high taxes or alternatively set up cumbersome and restrictive approved share option schemes.
EMI is intended to be considerably more tax efficient and flexible than the traditional arrangements for share option schemes. For example:


  • The EMI scheme requires no formal share option scheme - options may be granted by a single written agreement with the relevant employee;

  • There is no minimum exercise price (although if options are granted at a discount, there will be a tax liability on the discount);

  • Options may vest immediately and may remain exercisable for up to 10 years;

  • Options must be over fully paid up ordinary shares although the shares may have limited or no voting rights and may be subject to other restrictions;

  • There is no limit on the number of employees who may hold EMI options

  • Company does not need to have been incorporated in the UK.

There are though a number of important requirements including:



  • the value of options per employee is currently limited to £120,000 (and no discount is applied to any performance criteria before vesting);

  • there is an overall maximum limit of £3 million worth of shares (valued at the date of grant) over which EMI Options may be granted by any company;

  • the company must agree the value of the shares with the Inland Revenue unless the shares are listed on a recognised investment exchange;

  • the company (and its subsidiaries) must have gross assets of no more than £30,000,000;

  • only employees (under a contract of service) who work a minimum of 25 hours a week or 75% of their working time may be granted EMI options (and thus consultants, non-executive directors and contractors will not qualify for EMI options);

  • company must not have fewer than 250 employees;

  • options may not be granted to any person who, together with their relatives and associates, holds more than 30% of the shares in the company;

  • company must be an independent trading company mainly trading in UK;

  • the option must be notified to HMRC within 92 days (see below)

  • the company must not be under the control of another company;

  • all the companies within a group must be at least 75% controlled;

  • the option shares must be part of the ordinary share capital of the company which on exercise will be fully paid up and not be redeemable .

Certain companies will not qualify for EMI options if their activities are designated as excluded activities. Examples of excluded activities include the following:




  • dealing in land, commodities or futures etc;

  • dealing in goods otherwise than in the course of an ordinary trade of wholesale or retail distribution;

  • banking and related activities;

  • leasing or receiving royalties or licence fees (except where the fees are in respect of intangible assets created by the company;

  • legal or accounting services;

  • property development;

  • farming or market gardening;

  • hotel, nursing and care home management;

  • shipbuilding, coal and steel

  • providing services to another business which consists to a substantial extent (20%+) of excluded activities.

There is no approval or clearance process required but companies can apply (to HMRC’s Small Company Enterprise Centre or SMEC) for advance assurances that they qualify for EMI.


If the option qualifies as an EMI option, the company must notify SPEC within 92 days of granting the options. The notice must be accompanied by the relevant form and there must be declarations from employee and a director that the conditions for EMI options are satisfied. The Inland Revenue has 12 months after the 92 day period to disqualify an option for EMI tax treatment although the period is unlimited if the information provided was false or misleading.

Overview of Tax Advantages




Income tax


No income tax is payable on the grant of EMI options. In addition, provided that the exercise price is not less than the market value of the shares at the date of grant, no income tax or national insurance will be payable on exercise. If the EMI option is granted at a discount, income tax is payable on the amount of the discount. Beware though of a cash cancellation payment where the employee accepts a cash payment in place of exercising the option as such a payment will attract income tax. If income tax is payable and the shares acquired are readily realisable assets then National Insurance Contributions (cost of NICs depends on circumstances but might be 12.5%) will also be payable.

Capital Gains Tax


Capital gains tax (currently 18%) is payable on any shares qualifying for EMI treatment at the time of their disposal. This compares to income tax at a maximum rate of 50% on a sale of non-EMI qualifying shares (plus NICs of up to 12.5% when the shares are readily realisable).
Disqualifying events
EMI options may lose favourable tax treatment in several circumstances such as:

  • the company ceasing to be independent (such as on a takeover) or where it ceases to meet the trading activities requirement;

  • the employee does not work the required time;

  • the share capital is altered and it affects the value of the shares and certain other conditions are satisfied..

The EMI regime should be of great benefit to small companies wishing to incentivise their key employees by way of tax efficient options. The tax benefits will operate to the advantage of both the company and the option holder. However there are traps for the unwary and on a sale the tax charge instead of being a handsome 18% could be a nightmare 62.5%. Also given the disqualification rules and the tremendous difference between income and capital gains tax the search is on to come up with other mechanisms to incentivise employees with shares that do not carry the risks associated with EMI options.


For further information please contact:
Tom Mackay or Jennifer Carter Shaw

Mackay Carter Shaw LLP, Solicitors



www.mackaycartershaw.com

Tel: 0207 193 1009 or 1016

Email: tom@mackaycartershaw.com or jennifer@mackaycartershaw.com
This note is only a general review of the subjects covered and does not constitute legal advice which will vary depending on the circumstances of each case. No legal or business decision should be based on the contents of this note.


SHARES – OPTIONS – EMI SHARE OPTIONS (GUIDE)




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