EMI schemes can be complex, and our clients understandably have many questions about them. In this advice piece, we answer your EMI share option schemes FAQs, and also provide a glossary for the common terms you might come across when researching EMI share options.
Jump to individual EMI FAQs:
- What is the qualifying criteria for companies?
- What is a qualifying subsidiary?
- What are ‘excluded activities’ in relation to EMI schemes?
- What are the tax benefits of EMI schemes for a company?
- What information does your company need to provide to set up an EMI?
- What are the set-up costs of an EMI scheme?
- Do the shares need a valuation?
- Is prior approval required from HMRC for setting up the scheme?
- Does an EMI scheme have to be registered with HMRC?
- What do you have to notify HMRC about?
- Is a shareholders’ agreement needed to set up an EMI scheme?
- What is a disqualifying event?
- Is there a deduction or relief on corporation tax with an EMI scheme?
- Does an annual return have to be filed on an EMI scheme? If so, who does this?
What are the benefits of an EMI scheme?
An EMI scheme is a way of rewarding employees of small, usually high-risk, companies, with the option to purchase shares at a price agreed in advance. When the value of the company (and so the shares) later increases, they can benefit from exercising and then selling their shares at a profit. There may be some conditions on the time between the option being granted and it being exercised, such as an employee fulfilling a certain duration of employment, or when the company is sold.
Shares in an EMI scheme have favourable tax treatment. There is no income tax due on grant of the option (regardless of the exercise price, whether this is market value or discounted), or on exercise – provided the option is granted at market value and the relevant conditions are met. Instead, capital gains tax (CGT) is payable upon the disposal of the shares in respect of any chargeable gain. An employee stands to profit from their options when the company’s value increases and the employee exercises and then sells their shares at the increased market value – without the added burden of income tax deductions on the profits.
EMI share option schemes are an efficient and effective way of attracting and retaining talented staff in high-growth or high-risk businesses, to motivate and reward them for their hard work in an environment which is often more demanding than a usual 9-5 job. See our CEO Toby Harper explaining more about the benefits of EMI schemes in our video below.
What are the limitations or restrictions of EMI schemes?
EMI schemes are actually quite flexible. However, there are some conditions and requirements. These include:
- EMI options can’t be granted to non-executive directors or consultants – only employees.
- The maximum value that an employee can hold in unexercised shared options is £250,000 in any three-year period. Anything above this amount won’t qualify for the favourable tax relief.
- The types of shares over which options are granted must be ordinary shares that are fully paid up. They can’t be convertible or redeemable shares.
- Shares cannot be transferred, other than to personal representatives. The shares must also lapse within 12 months of death of the employee.
- The total initial market value of all unexercised EMI options held by all employees is limited to £3 million.
- The option must be able to be exercised within ten years of it being granted.
- If the company is part of a group, only the parent company can grant the EMI shares.
What is the legislation that governs EMI?
The legislation that governs EMI options is known as the EMI code and is contained in the Income Tax (Earnings and Pensions) Act 2003, sometimes known as ITEPA 2003. The relevant parts in this legislation that relate to EMI schemes are:
- Part 7, Chapter 5, sections 471-478 (concerning basic taxation and provisions on taxation);
- Part 7, Chapter 9, sections 527-541 (concerning income tax exemptions and reliefs, and disqualifying events);
- Schedule 5 (detailed provisions on the requirements that must be met and notifying HMRC).
What is the qualifying criteria for employees?
To qualify for an EMI share option, an employee must:
- Be an employee of the qualifying company or one of its qualifying subsidiaries;
- Work (or be committed to work, with the exceptions of sick leave or parental leave and so on) at least 25 hours a week, or 75% of their working time (if less than 25 hours);
- Not own or control more than 30% of the share capital of the company (or any other company belonging to a qualifying group of companies).
In addition, the employee can hold SAYE options alongside EMI options, if they are HMRC approved. However, they can only hold an option in a Company Share Option Scheme (CSOP) if the total of the CSOP and EMI options is under £250,000.
What are the tax benefits for an employee?
Provided that the employee is granted a share option at market value (and not at a discounted price) and the other conditions of the EMI code are met, they will be liable to pay only CGT on selling the shares in respect of any chargeable gain, rather than being subject to much higher income tax rates (potentially up to 45% dependent on their individual tax threshold) on exercise of the options. The employee can also use their annual CGT exemption.
What happens to EMI shares if an employee leaves or is made redundant?
Usually an employee who leaves the company through resignation or dismissal would lose their option to purchase shares. However, a distinction can be made for ‘good leavers’ whereby, provided an employee is allowed to exercise within 90 days of leaving the company, the tax advantaged status of the option is (usually) preserved.
Is Entrepreneurs’ Relief available on EMI options?
Yes, Entrepreneurs’ Relief can apply to EMI options, if the employee qualifies and provided that the option has been held for at least twelve months. If the employee qualifies for Entrepreneurs’ Relief, they can benefit from paying the reduced 10% rate of CGT on any gains up to £10million.
What is the qualifying criteria for companies?
To qualify for EMI schemes, companies must meet certain conditions. Each time an EMI option is granted, the company must:
- Have fewer 250 employees (or the full-time equivalent).
- Be independent – that is, not a 51% subsidiary of another company, or controlled by another company.
- If the company has its own subsidiaries, it must own and exclusively control all of those subsidiaries (owning more than 50% of the ordinary share capital), and those subsidiaries must also qualify.
- Have gross assets of less than £30million – this is a consolidated valuation of the gross assets of the group, without any liabilities deducted.
- Be trading, or preparing to trade, on a commercial basis with a view to making profits, in a qualifying trade and not substantially (more than 20%) in trades relating to ‘excluded activities’.
- Have a UK permanent establishment, or, if the company is a parent company that owns a group, one of its subsidiary companies (which must also meet the qualifying criteria) in a qualifying trade must have a fixed business place or agent in the UK.
What is a qualifying subsidiary?
A subsidiary is any company which the holding company controls, either solely or with a connected person. A subsidiary qualifies if it’s a 51% subsidiary of the holding company, and no other party controls it, except the holding company or another one of its subsidiaries. Property management subsidiaries won’t qualify unless they are a 90% subsidiary of the holding company.
The holding company can have minority shareholdings – which won’t be regarded as a subsidiary. However, it can’t have a joint venture holding as a subsidiary.
What are ‘excluded activities’ in relation to EMI schemes?
Excluded activities means trades that are not ‘qualifying trades’. Companies who work substantially in ‘excluded activities’ aren’t eligible to offer EMI options. HMRC usually takes ‘substantially’ to mean more than 20% of the company’s trading activities. Broadly, the excluded activities are:
- Land, commodities, shares, securities of financial instruments
- Goods, except in wholesale and resale distribution
- Banking, insurance, money-lending HP financing or other financial activities
- Leasing or receiving royalties or licence fees
- Property development
- Legal or accountancy services
- Forestry, including producing timber, and holding, managing or occupying woodland
- Ship building
- Operating or managing hotels
- Operating or managing nursing homes or residential care homes
- Steel and coal production
However, the law can be very complex: if your company is a parent company and excluded activities make up more than 20% of your entire group’s trading activities, or if, for example it reinvests its own cash back into investment portfolios, it could then be regarded as engaging in financial activities, which are on the list of excluded activities.
This is why it’s always advisable to seek expert legal advice!
What are the tax benefits of EMI schemes for a company?
The main benefit of a company using an EMI scheme is to attract, employ and retain key talented staff, who may have taken a risk in choosing to work for early-stage entrepreneurial businesses. EMI schemes act as a great incentive for employees as they allow them to benefit from the company’s growth.
Plus, the set up and running costs are small, parts of which can be deductible expenses against corporation tax.
What information does your company need to provide to set up an EMI?
If you instruct us to help your business set up an EMI scheme, we will need the following information from you:
- Names of employees to be included in the scheme;
- How many share options each employee will be granted;
- Details of the time frames and conditions for exercising their options and buying the shares;
- Prices and costs of the options, and valuations that informed those prices (if available);
- Your last 3 years’ accounts (or fewer if your business is a new start-up);
- Any shareholders’ agreements and articles of association.
What are the set-up costs of an EMI scheme?
There are two main parts to administering an EMI scheme:
- The establishment of the scheme and the preparation of its documentation, in order to register the scheme with HMRC and to grant EMI options (which includes applying for a valuation with HMRC, applying for advance assurance that the company qualifies to grant EMI options, preparing all EMI option scheme documentation and notifying the grant of EMI options to HMRC); and
- Annual reporting obligations to HMRC.
We would usually give a time estimate of around 18-21 hours of legal work in order to establish an EMI scheme. You can find out more about our prices here, and decide which of our service plans is right for your business.
Do the shares need a valuation?
Yes, it is highly recommended that if the company is unquoted, then the market value of the shares is agreed with HMRC prior to granting any options (only options granted at market value will attract the favourable tax relief upon exercise).
If there has been a recent arms’ length share issue by the company, we can use this price as a starting point to agree a market value price with HMRC. It is often possible to agree a discount on such starting point of around 50% – 60%. Alternatively, the company can appoint either an accountant or a professional valuer to calculate the value of the shares. HMRC aims to respond to a valuation request within 4 weeks of receiving an application.
Once agreed, the valuation is valid for 60 days from the date of issue, so the options must be granted within that period.
If the company is a quoted company, HMRC will accept the mid-market value of the shares on the date the option is granted.
Is prior approval required from HMRC for setting up the scheme?
No, prior approval is not needed. It is, however, possible to obtain advance assurance from HMRC that the company qualifies to grant EMI options. The scheme must be registered with HMRC once options have been granted.
Does an EMI scheme have to be registered with HMRC?
Yes, the EMI scheme must be registered with HMRC. This must be done through the employment-related securities (ERS) online service. We can help with this if required.
What do you have to notify HMRC about?
As well as registering the scheme, HMRC must be notified of the grant of an EMI share option within 92 days of the date it was granted.
If an EMI option is not notified to HMRC within this time limit, the tax benefits of the option could be lost.
Is a shareholders’ agreement needed to set up an EMI scheme?
A shareholders’ agreement is not required in order to establish an EMI scheme. However, we would always recommend that a shareholders’ agreement be put in place where multiple shareholders exist.
What is a disqualifying event?
A disqualifying event is an event that affects the tax advantaged status of an EMI option. If the share option is not exercised within 90 days of a disqualifying event, the tax advantages for the employee will be restricted.
Disqualifying events include:
- the company ceasing to be independent (for example, it is owned by or becomes a subsidiary of another company);
- the company’s trading activities falling substantially (for example, more than 20% of its total trading activities) into the list of excluded activities;
- the employee no longer qualifying – for example, they cease to be an employee or no longer satisfy the working time commitment of 25 hours a week (or 75% of their working time);
- the option being altered, either to increase the underlying value of the share, or so that it no longer meets the requirements of the legislation that governs the scheme;
- the share capital of the company being changed so that it no longer qualifies;
- the shares being converted to a class that no longer qualifies.
Is there a deduction or relief on corporation tax with an EMI scheme?
Yes, the operating costs of the scheme can be a deductible expense on the company’s corporation tax. In addition, companies can also receive a corporation tax deduction when the employee exercises their option. This deduction will be equal to the market value of the exercised shares, minus any payments received by the company from the employee.
Does an annual return have to be filed on an EMI scheme? If so, who does this?
Yes, an annual return must be filed by 6th July following the end of the preceding tax year. This must be done online via the ERS online system. We can assist with this if required.
Articles of Association
One of the constitutional documents of the company, which sets out the basic management and administrative structure of the company.
The process by which option shares are acquired in accordance with the terms of the option agreement. An option holder is issued with shares in the company in exchange for paying the exercise price and completing an exercise notice.
ERS online service
This is the government online service where companies can register and notify HMRC of their EMI share option scheme. Your company will need to be registered to use HMRC Online Services before you can use it.
The sale of shares.
The award or issuance of the share options to the employee.
The expiry/automatic termination of the right to purchase shares pursuant to the terms of a share option agreement.
Unapproved scheme or unapproved options
A non-tax advantaged share option scheme.
The point at which the beneficial interest of a share option transfers to the option holder and may be exercised (subject to meeting any other exercise conditions set out in the option agreement). It is common to have a period of vesting (for example. four years) before the option becomes eligible to be exercised.