Dive into the world of PAYE investigations. Uncover the facts, implications, and insights in this informative blog
If you are considering awarding shares to your employees, an Enterprise Management Incentive is often the best place to start.
Referred to as EMI share schemes, they are a particularly flexible way of managing the process and they are tax-efficient too.
However, like many financial structures, they have to meet certain criteria to qualify for the tax breaks. This guide takes a look at the operation of an EMI share scheme and the conditions that must be fulfilled.
EMI share schemes are approved by HMRC and were initially introduced in 2000. Since their introduction, the rules have been changed making them even more attractive.
Both the employer and the employee can enjoy the benefits of an EMI but only if they both meet their respective qualifying conditions.
Apart from their tax efficiency, one of the reasons that EMI schemes are so popular is their flexibility. Any employee can be included in an EMI share scheme but they do not have to receive shares on equal terms.
EMI schemes are usually popular with shareholders and studies suggest that companies that offer EMI schemes tend to perform better. By providing a potentially lucrative benefit, there is also the opportunity to retain key staff, thus reducing the costs of recruitment.
Although there are sets of qualifying criteria for both the employer and employee, the good news is that they are not especially onerous or exhaustive. There is not anything complicated about the rules and it is fairly simple to ascertain whether you meet the criteria.
To be eligible to participate in an EMI share scheme, employers must meet these conditions:
- The value of the gross assets must be lower than £30 million
- The company must be a trading business (rather than an investment company, for example)
- The company must not be controlled by another company, nor be a subsidiary
- At the date EMI options are granted, there must be fewer than 250 employees
If your company fulfills the above criteria, you will need to check the employee eligibility:
- They must be employed by either the company or a subsidiary
- They must spend a minimum of 25 hours, or 75% of their working hours, as a company employee
- No more than 30% of the company shares must be held by a single employee
If all of the above criteria are fulfilled, the last set of rules that must be followed relating to the share options:
- They must be issued as ordinary and non-redeemable shares
- The total value of any share options including EMI must not exceed £250,000 per employee. Any amount over this value will fall outside the EMI share scheme and will be known as unapproved share options
- The options must be exercisable within 10 years
- The total value of the shares provided must not exceed £3 million
- Written terms relating to the options must be provided and they must stipulate that the rights cannot be transferred. All other conditions of the EMI share scheme are flexible and can be decided by the employer.
As mentioned above, EMI Share Schemes provide certain tax efficiencies providing all of the qualifying criteria are met. If they do then they are approved schemes. If they do not then they are unapproved schemes.
Shares which fall within the scheme and are granted at the market value will not be subject to either Income Tax or National Insurance. Also, the company can deduct the difference in exercise price less the price paid against corporation tax.
It is recommended to ask HMRC to approve the market value of the shares before they are issued to prevent an enquiry or any unexpected liability at a later date. Once a valuation is agreed the company has 90 days (extended to 120 days during COVID restrictions) to issue the shares.
If the shares are classed as unapproved and fall outside the scheme, the difference between the market value and the amount paid will be treated as a salary or bonus. This means the figure will be liable for Income Tax and National Insurance.
When the rights are exercised, the employee will only be required to pay the pre-agreed market price. No liability will immediately fall on the difference in value. However, once the shares have been acquired, upon disposal the profits may be subject to Capital Gains Tax. The usual CGT annual exemption can be used to offset any liability.
When the rights are exercised, the employer will be able to claim a deduction in Corporation Tax. This is usually equal to the market value at the date the option was exercised minus the amount the employee paid. In addition, no National Insurance contributions are payable by the employer.
If the above information sounds interesting, take a look at these FAQs for answers to some of the most common questions.
Can universal terms and conditions be used?
Yes. It is possible to use universal terms and conditions alongside an option agreement that has been individually drafted for the employee.
Do HMRC need to approve the scheme first?
You can choose to get HMRC to agree on the scheme if you prefer but it is not mandatory. Once an option has been granted, the only requirement is to inform HMRC within 92 days.
Can the tax efficiencies be lost?
If either the employee or employer ceases to meet the qualifying criteria before the options are exercised, the tax efficiencies will be removed. This is known as a disqualifying event.
Does the share scheme need to be reported in any way?
A tax return must be made to HMRC by 6th July every year by every company that has any EMI share options. This is the case even if there have been no changes to the scheme, such as new members or leavers.
What happens if a report is not submitted to HMRC?
Failing to submit a report to HMRC on time will result in a financial penalty. These start at £300 but can rise to more than £1,000. The scheme may also be at risk due to non-reporting. The penalties will apply even if there are no changes to report to HMRC.
What happens if the employee dies before exercising their rights?
It is possible to include terms that permit the rights to be exercised after the employee's death, but these rights must expire within one year.