What is EMI share options scheme and why you and your employees should have one?
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Finding, rewarding and keeping highly skilled and talented employees incentivised is easily one of the top concerns most founders and leaders are faced with day in and day out.
EMI share option schemes are a popular and extremely useful tool in your total compensation positioning toolbox.
Before we dive into the benefits for your employees, let’s get you familiar with what an EMI scheme is, what it can do for you, and why you might want one!
What is an EMI scheme?
EMI stands for Enterprise Management Incentive. It’s a share option scheme supported by the UK government. It allows tax-advantageous issuing of options and is used by over 12,000 UK companies! These equity schemes are most common among startups and small to mid-sized businesses.
What does an EMI scheme do?
EMI schemes make sharing ownership with employees tax-efficient and allow flexible option granting. These options give your employees the right to acquire shares in your company at an agreed price (the ‘exercise price’) once specific requirements are met. The exercise price is usually equal to the market value per share at the date options are granted.
Typically, the requirements come in the form of performance and/or time-based hurdles. This incentivises employees to increase the share value through hard work and performance and aligns the financial goals of the company directly with their (fingers crossed) payout!
The benefit to employees comes when the underlying value of the shares increases and the shares are sold to make tax-advantaged profits!
Why would I want an EMI Scheme?
EMI option schemes have two key advantages over other types of option schemes: tax benefits and flexibility.
1. Tax benefits for employees
If an EMI option is exercised within ten years of grant, no income tax or National Insurance contributions (NICs) will be payable when the shares are issued to the employee! This is provided the shares are bought at a price at least equal to the market value at grant.
Capital gains tax (CGT) will only be payable by the employee on the sale of the shares if they increase in value. The current CGT rate of 10% is discounted from the standard rate if the shares are sold two years after the EMI option is granted.
Tax only being paid upon sale of the shares and the CGT discounted rate make EMIs more tax-advantageous than non-tax-advantaged option schemes.
To illustrate the tax benefits, let’s consider two employees and their outcomes (assuming no exercise price): Frank and Dolly.
Non-tax advantaged options example
Frank is granted an unapproved option to acquire shares of Music Ltd at a market value of £20,000.
Four years later, he exercises the option. The company valuation has increased 10x, so, assuming all things remain equal, the option is now worth £200,000. Two years later, he sells the shares for £250,000.
Frank does not pay tax when the option is granted. However, he does pay tax upon exercise. His earnings of £180,000 (market value at the time of exercise - market value at the time of grant, i.e. £200,000 - £20,000) are taxed as income at Frank’s marginal tax rate of up to 45% or £81,000.
Keep in mind, at this point, Frank has not received any cash from holding these options (another reason why EMI options are more favourable for the employee!).
Finally, upon selling the shares two years later, Frank pays a further 20% CGT of £10,000 on his £50,000 gain.
Frank will have paid up to £91,000 in tax, most of which before he receives any cash.
EMI options scheme example
On the other hand, Dolly is granted an EMI share option to acquire shares in the same company at a market value of £20,000.
Four years later, she exercises the option with the shares now worth £200,000. Two years later, she sells the shares for £250,000.
Dolly will not have to pay tax when the option is granted. She also will not have to pay any income tax when she exercises it. Dolly will only have to pay £23,000 of CGT at the time of sale at the reduced rate of 10% (or £23,000) on her £230,000 gain (market value at the time of sale - market value at the time of grant, i.e. £250,000 - £20,000).
Unapproved Option Payout: £159,000
EMI Share Option Scheme Payout: £227,000
In comparison, Dolly will pocket £68,000 (70%) more than Frank!
2. Tax benefits for employers
When exercising EMI options, employers could potentially be exempt from NICs. Your business can also benefit from a corporate tax deduction equal to the difference between how much your employees paid for the shares and their market value at the time of exercise.
In general, companies have a lot of flexibility regarding EMI scheme operations! Companies are free to grant EMI options to any employees and to select vesting and employment conditions for the EMI option.
Contact our team to chat about different option plans and to find out which best applies to your company!
This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.