Enterprise Management Incentives

24 October 2006

Latest Government statistics show EMI is going from strength to strength, are you missing out? We deal with some popular misconceptions.

EMI Goes from Strength to Strength

Government statistics published on 30 June 2006 show a further 2,500 new EMI plans were introduced in 2005 making it likely over 100,000 employees have now been granted EMI options since EMI was launched in March 2000. These statistics make EMI the most successful tax-approved employee share plan for small companies ever.

EMI is the most tax favoured discretionary share plan, the tax treatment is broadly:

  • No tax on grant

  • No income tax on exercise (unless granted at a discount and then only the discount on grant is subject to income tax)

  • CGT (Capital Gains Tax) on the sale of the shares - business asset taper relief runs from the grant of the option

The taper relief means it is possible for higher rate taxpayers to exercise the option, sell the option shares immediately and pay CGT at an effective rate of just 10% (ignoring exemptions, spouse/registered partner transfers etc).

In addition, the UK employing company will qualify for a statutory tax deduction equal to the gain on exercise of the option (i.e. the market value of the option shares on exercise less the exercise price (if any)) - the deduction is not unique to EMI.

Click here for more detail on the EMI conditions and tax treatment.

So if you don't have an EMI plan yet, should you?

Listed Companies

It is a popular misconception that companies on the full list or traded on AIM cannot qualify for EMI. They can if they have gross assets of £30 million or less and satisfy the other trading requirements.

The gross asset limit was raised from £15 million to £30 million on 1 January 2002. We suspect many listed and AIM traded companies are unaware of this generous relaxation. If gross assets later exceed the limit it does not affect existing qualifying options, it only means further qualifying options cannot be granted while the limit is exceeded.

Gross assets are generally as per the most recent accounts but if you are "on the border" click here.

Another misconception is that EMI can only apply to "market value" options not the more popular performance share plans, long term incentive plans ("LTIPs") or deferred bonus plans (which involve free shares). In fact EMI can be used for all these plans because the legislation allows options to be granted with a nil exercise price.

Listed Company Example

A listed company with operations overseas in addition to those in the UK recently used EMI to introduce an LTIP. The company had gross assets below £30 million (many service companies satisfy this test even with market capitalisations well in excess of £30 million).

The plan enabled the remuneration committee to grant UK participants awards structured as nil cost EMI options. Confirmation was obtained fom the Small Companies Enterprise Centre that the company satisfied the EMI conditions.

Gains made by UK participants in excess of market value on grant will be taxed as capital (and the company will save employers NIC) as a result of incorporating these minor additional features.

Amending Existing Plans

It is often possible to amend existing plans to allow EMI options to be granted in the future without seeking shareholder approval (assuming the rules contain the usual wording which permits amendments to secure more favourable tax treatment).

Unlisted Companies

EMI allows unlisted companies to provide employees with a powerful tax-efficient incentive to work towards a successful exit at no cash cost. Other of our clients also use them as part of an effective internal share market. The narrative below only deals with the former scenario.

We frequently introduce EMI plans for unlisted companies planning to exit in the short to medium term. Options typically become exercisable when an exit is achieved.

The market value of option shares on grant is determined by reference to the CGT value of a small minority holding. This means it is often possible to agree a value for the option shares which is discounted substantially from the value of the company as a whole.

The exercise price is typically set at market value on grant to ensure no income tax is payable on exercise. On exit, participants frequently receive the same price per share for their option shares as majority shareholders thereby benefiting from a "double uplift" in value, all of which is taxed as capital.

In addition, companies receive a statutory corporation tax deduction when the option is exercised on the difference between the market value of the option shares on exit and the exercise price. This deduction can give rise to a "deferred tax asset" for which the vendors may receive credit.

We can provide grant documentation which allows an attorney to exercise options on behalf of participants and to sell the option shares on their behalf to allow a smooth exit.