The EMI Plan is a tax advantaged option arrangement aimed at small growing companies to help them recruit and retain employees. EMI has been available since 29 July 2000. This paper outlines the conditions which need to be met and the tax treatment of EMI options.
1. Qualifying companies
To be eligible to grant options over its shares under an EMI arrangement a company must:
- be independent; and
- have gross assets of £30m or less;
- have only “qualifying subsidiaries”;
- carry on only qualifying trades; and
- (after the Finance Act 2008 receives Royal Assent) have fewer than 250 full-time employees.
In addition there is an overall “Purpose Test”. In order to be a qualifying option for the purposes of the EMI Plan, an option must be granted for commercial reasons to recruit or retain an employee in a company, and not as part of a scheme or arrangement, the main purpose, or one of the main purposes of which is the avoidance of tax.
A company whose shares are subject to EMI options must not be
- a 51% subsidiary (more than 50% of its ordinary share capital owned by another company), or
- controlled by another company (or another company and persons connected with it).
Arrangements must not exist which could result in the company becoming a 51% subsidiary or otherwise being controlled.
Control in this context means the power of one company to ensure that the affairs of another company whose shares are subject to EMI option are conducted in accordance with that company’s wishes. This may be through share ownership, voting power, or because of any powers conferred by Articles of Association or other document.
The company must not have gross assets exceeding £30 million. Gross assets are as shown in the company’s balance sheet (or in the consolidated balance sheet in the case of a group).
The company must hold directly or indirectly more than 50% of the ordinary share capital of all its “subsidiaries”. The definition of subsidiary is wide and includes any company which the company acts together with others to control. This can cause problems where a company has 50:50 joint ventures because HM Revenue & Customs consider the shareholders of the company are “acting together” with the other owners of the joint venture company to control the JV. This interpretation can mean the JV is technically a subsidiary but is not qualifying if it is 50% or less held. A company that has JVs may be ineligible to grant EMI options.
A trade is qualifying if:
- it is carried on wholly or mainly in the UK;
- it is conducted on a commercial basis with a view to profits; and
- it does not consist wholly or substantially in the carrying out of “excluded activities” (see below).
The trading activities requirements of a single company are that the company:
- disregarding any incidental purposes, exists wholly for the purpose of carrying on one or more qualifying trades; and
- is carrying on a qualifying trade or preparing to do so.
For a group:
- the business of the group must not consist wholly or as to a substantial part in carrying out non-qualifying activities; and
- at least one group company must be carrying on a qualifying trade or preparing to do so.
A trade will not qualify if one or more excluded activities together amount to a substantial part of it (the HM Revenue and Customs say “substantial” is more than 20% of the trade). Excluded trading activities are:
- dealing in land, commodities or futures, or shares, securities or other financial instruments;
- dealing in goods, otherwise than in the course of an ordinary trade of wholesale or retail distribution;
- banking, insurance, money-lending, debt-factoring, hire purchase financing or other financial activities;
- leasing (including letting ships on charter, or other assets on hire) or receiving royalties or other licence fees;
- providing legal or accountancy services;
- property development;
- farming or market gardening;
- holding, managing or occupying woodlands, any other forestry activities or timber production;
- operating or managing hotels or comparable establishments or managing property used as a hotel or comparable establishment;
- operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home;
- providing services or facilities for a business carried on by another person if
- the business consists to a substantial extent of excluded activities, and
- a controlling interest in the business is held by a person who also has a controlling interest in the business carried on by the company providing the services or facilities; and
- (after the Finance Act 2008 receives Royal Assent) shipbuilding, coal and steel production
Two exceptions to the excluded activities are
- the receipt of royalties and licence fees, where the amounts received can be attributed to the exploitation of relevant intangible assets. A relevant intangible asset is one, the greater part of which (in terms of value) has been created by the company carrying on the trade, or by another company in its group. Intangible assets are defined in line with normal accounting practice
- ship chartering, where the ship is owned by the company and certain other conditions are satisfied.
Note: there is no requirement for the company to be incorporated in the UK or resident in the UK.
Fewer than 250 employees
After the Finance Act 2008 receives Royal Assent, companies must have fewer than 250 full-time employees. These can be calculated by adding to the number of full-time employees a just and reasonable fraction for each part-time employee.
2. Eligible employees
To be eligible to be granted EMI options, employees must satisfy 3 tests:
(i) Employment – an employee is an eligible employee in relation to a company only if he is an employee of the company or one of its subsidiaries (although he may also be a director).
(ii) Working time commitment – an employee is an eligible employee in relation to the relevant company only if his “committed time” amounts to:
- at least 25 hours a week; or
- if less, 75% of his “working time”.
“Committed time” means time spent on the business of the relevant company or if an individual is employed by a parent company, time spent on the business of the group. It includes any time which the employee would have been required to spend but for time away for illness, holiday, maternity, paternity or parental leave.
Working time means time spent on “remunerative work” (as an employee or self-employed person). Remunerative work means “general earnings” to which sections 15 or 21 Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) applies and work done for profit which is chargeable to tax under Case I or II of Schedule D or, in either case, which would be so chargeable if the employee were resident or ordinarily resident in the UK.
(iii) No material interest – EMI options may not be granted to an employee who has a material interest in the company.
A material interest is ownership of, or the power to control, directly or through the medium of other companies or by any other indirect means, more than 30% of the ordinary share capital of the company (or additionally 30% of assets on a winding-up in the case of close companies).
Note that options over shares of a company (but excluding any qualifying EMI option) count towards the 30% test. If an individual acquires a material interest after being granted an EMI option, it does not affect that option but would prevent him from being granted further EMI options whilst he has such an interest.
Inter-relationship with approved company share option plans (“CSOP”)
The tax advantages of EMI will be lost if an employee holds unexercised options under a CSOP and EMI options which together have a total market value at the date of grant of more than £120,000 (with effect from 5 April 2008). If the full £30,000 worth of CSOP options have already been granted this restricts the EMI £120,000 limit to £90,000.
3. Qualifying options
In order to qualify under EMI, options must:
(i) be granted over shares which:
(Shares may be subject to restrictions)
(ii) be capable of exercise within 10 years from grant, but the option period can be longer (in practice this is unlikely to be the case – note the tax consequences under “Tax and NIC Treatment of EMI Options”).
(iii) be granted pursuant to a written option agreement (see later under “Operation of an EMI Arrangement”);
(iv) not be assignable; and
(v) lapse within 1 year of the death of the optionholder.
Qualifying options can be granted under one or more EMI agreements, but once the £120,000 limit is reached (regardless of whether options have been exercised or released) no further options granted to the optionholder within 3 years of the last qualifying grant will be qualifying options. This 3 year rule can be avoided by specifying an individual limit in the EMI Plan rules of £119,999 on the value of shares which may be subject to qualifying options so the £120,000 limit is never reached.
There is no limit on the number of employees who may be granted EMI options but there is a limit of £3 million on the total value of shares which may be subject to unexercised qualifying EMI options.
4. Operation of an EMI arrangement
EMI is a selective arrangement, EMI options may be granted on a discretionary basis.
The written agreement between the employee and the grantor of the EMI option must state:
- the date on which the option is granted;
- that the option is granted under the provisions of Schedule 5 to ITEPA;
- the number (or maximum number) of shares that may be acquired;
- the price (if any) payable by the employee to acquire the shares;
- when and how the agreement may be exercised; and
- any restrictions which apply to shares that may be acquired (e.g. where the shares are subject to a risk of forfeiture).
The agreement must set out details of any performance conditions attaching to the EMI options. (Note – the use of performance conditions does not reduce the value of the shares subject to the EMI option).
It is possible to apply to HM Revenue and Customs to confirm whether the company is a qualifying company but not whether other aspects of the EMI legislation are satisfied (such as whether the plan rules are acceptable or whether employees are eligible). To apply for clearance the company secretary, a director, or an agent acting on the company’s behalf, may submit details of the company in writing to the Small Companies Enterprise Centre.
The employer company must notify HMRC’s Small Company Enterprise Centre within 92 days of the grant of an EMI option. Companies must send notification of the grant on form EMI 40 which includes:
- a declaration by the employee that he or she satisfies the working time commitment; and
- a declaration by a director or the company secretary of the employer company that the requirements of Schedule 5 are met; and that the information provided is to the best of his or her knowledge correct and complete.
Value of shares
For companies not listed on the London Stock Exchange, the market value of shares over which EMI options may be granted must be agreed at grant to determine:
- that the £120,000 and £3 million limits are not exceeded; and
- whether there is any discount to be taxed on exercise (see later)
but the market value of EMI options need not be agreed with HMRC prior to grant. The Notice may be completed on the basis that options over that number of shares which equals the £120,000 value (which is, in due course, agreed with HMRC) will be qualifying EMI options but any excess will not. Given that the company must ascertain the value of the shares, however, it makes more sense to agree the value of the shares with HMRC in advance of grant.
The market value of any shares for this purpose is the price they might reasonably be expected to fetch on a sale in the open market, free from any restrictions or risk of forfeiture to which they may be subject.
HMRC has the right to raise enquiries on the Notice for 12 months after the end of the 92 day Notice period. If no queries are raised it will be taken that the EMI option qualifies.
5. Tax and NIC Treatment of EMI options
The advantage of the EMI Plan is that there is no income tax or NIC chargeable on either the grant or exercise of the options provided:
- the exercise takes place within 10 years of the grant of the option; and
- the exercise price is not less than the market value of the shares at the date they are granted (if this is not the case the discount is chargeable to income tax on exercise).
The disposal of the resulting shares is charged to CGT. For disposals on or after 6 April 2008 CGT is payable at a flat rate of 18% on gains (after annual exemption and losses).
Where “qualifying” replacement EMI options are granted the 10 year period during which they must be exercised in order to preserve the tax and NIC treatment runs from the date of grant of the original option.
Operation of PAYE and NIC
Where there is a charge to income tax on exercise of an EMI option and the shares are Readily Convertible Assets (RCAs), the employer must operate PAYE. All listed shares or shares traded on AIM or OFEX will be RCAs. Otherwise shares will be RCAs if trading arrangements exist, this will be the case if the company achieves (or is about to achieve) an exit by means of a trade sale or float. If the shares are RCAs, NIC will also be payable by the employee and employer. It is possible for the employee and employer to elect jointly for the employee to pay any employers’ NIC which arises on the exercise of EMI options.
Chapters 2 to 4 ITEPA contain wide-ranging anti-avoidance rules which were introduced by the Finance Act 2003. These apply to shares acquired by employees by reason of their employment. Shares acquired on the exercise of EMI options will be "restricted securities" for the purposes of Chapter 2 if any restrictions apply to the shares (e.g. transfer restrictions imposed in the company's articles of association).
Participants who exercise EMI options will automatically be deemed to have elected to pay income tax on the "unrestricted" market value of the shares they acquired under section 431 ITEPA (unless the option was granted at a discount or the exercise occurs more than 40 days after a “disqualifying event”). No income tax arises as a result of making the election but the effect of the election is to relieve the optionholder from subsequent charges which would otherwise apply under the restricted securities rules when the shares are sold or when any restrictions lift.
Other charges imposed by the anti-avoidance regime in Chapters 3 and 4 ITEPA still potentially apply to shares acquired pursuant to the exercise of EMI options (e.g. charge on the sale of shares at more than market value).
The EMI legislation contains a wide range of “disqualifying events”. There are broadly two types: disqualifying events which relate to the company and disqualifying events which relate to the employee.
If an option is exercised within 40 days of a disqualifying event, it has no effect on the tax treatment.
If an option is exercised more than 40 days after a disqualifying event, this may result in an income tax charge when the option is exercised. Tax is charged on the amount (if any) by which the market value of the shares, when the option is exercised, exceeds their market value immediately before the disqualifying event (the gain made before the disqualifying event escapes income tax and NIC).
Disqualifying events are:
- the company ceasing to satisfy the independence test;
- the company ceasing to meet the trading activities test (this will need close monitoring by the company);
- the employee ceasing to be an eligible employee because:
- he ceases to work for the relevant company; or
- he ceases to satisfy the working time commitment;
- any alteration to the option:
- to increase the value of the underlying shares; or
- so that the requirements of Schedule 5 are no longer met;
- any non-qualifying alteration to the share capital of the company;
- a non-qualifying conversion of shares from one class to another; and
- the grant of options under a CSOP which would (when added to unexercised EMI options) take the aggregate market value of the shares subject to such unexercised EMI options (measured at the date of grant) to over £120,000.
Note: A disqualifying event is likely to occur when participants leave. EMI Plan rules typically provide for the options of bad leavers to lapse on cessation of employment. The treatment of good leavers, however, depends on whether the company is listed or not. For listed companies, the leaver rules of the plan will usually comply with the guidelines of the Association of British Insurers. For unlisted companies, the plan rules usually say the options of good leavers lapse after 40 days; if the performance target (typically an exit) has not been achieved the option will usually lapse without ever becoming exercisable.
6. Take-overs and re-organisations
A take-over will usually be a disqualifying event if it results in the company losing its independence. The beneficial tax treatment of EMI options will be preserved, however, if the options are exercised within 40 days of the change in control. EMI plans often permit options to be exercised immediately before a change of control.
It is helpful to be able to roll-over EMI options where there is a technical change of control (e.g. where a new holding company is created as part of a group re-organisation). In addition, a roll-over alternative may be offered on a take-over.
Where there is a qualifying exchange of shares, an EMI optionholder can be granted replacement EMI options over shares of the acquiring company, provided:
- the acquiring company is independent;
- the trading activities test is satisfied;
- the optionholders remain eligible employees;
- the options are qualifying EMI options;
- the total value of the replacement options matches that of the original options; and
- the new aggregate exercise price matches the original price.
Therefore, an existing EMI optionholder may be granted replacement options after a take-over by a company (even if it has gross assets of over £30 million) and preserve the beneficial tax status of his EMI options.
This paper is based on the law as at 27 March 2008.