An update on EMI Share Options: A useful employee incentive tool for tech start-ups
One of the key issues for Tech Start-ups is attracting, retaining and motivating key personnel whilst also keeping a control on overheads. Employee Management Incentive (EMI) share options can offer a useful mechanism for providing such an incentive without the immediate cash flow implications of giving a key employee a pay rise.
Further to this, recent proposals to changes in the law regarding entrepreneurs' relief ("ER") means that they are an increasingly attractive option from a tax perspective.
EMI Share Options in a nutshell
- An employee share option (the "Option") is a contractual agreement usually between an employer company and an employee (the "Option Holder") whereby the Option Holder is entitled to exercise the Option at some point in the future to acquire shares in the employer company for a set price (the "Exercise Price").
- The Option Holder's right to exercise the Option is at his or her complete discretion and can be contingent on the occurrence of a specified event, such as the employer company being sold, listed or achieving a certain financial milestone.
- EMI Options are share options that (providing the employer company, the employee and the Option agreement meets certain eligibility requirements) are tax favoured in that no income tax or National Insurance Contributions are payable both on grant and exercise of the Option provided that the Exercise Price is set at market value at the date of grant. Further, any gain in value of the shares from the date of grant of the Option will be charged at the currently more favourable capital gains tax rate.
However, upcoming changes in legislation mean that ER will be more readily available to those who acquire shares pursuant to an EMI Option, meaning that capital gains tax will only be levied at 10% on the chargeable gain.
EMI Options and Entrepreneurs' Relief
The draft Finance Bill 2013 contains provisions which, if enacted in their current form, will extend the availability of ER to those who have been issued shares pursuant to the exercise of an EMI Option.
The key benefit of the availability of ER is that it reduces capital gains tax to 10%,(subject to a lifetime limit of £10 million).
The key changes that have been announced include:
- the minimum shareholding requirements for ER will no longer apply to an individual holding shares pursuant to an EMI Option. Under ER the usual minimum holding requirement is 5% of the voting shares (this change will apply to EMI options exercised after 6 April 2012);
- the minimum holding period of one year for ER will start to run from the date that the EMI Option is granted and not the date of acquisition of the shares as is currently the case for EMI options exercised after 6 April 2013; and
- an individual will retain EMI tax advantages following a 'disqualifying event' (i.e. termination of employment, certain variations to the terms of the options, the company ceasing to carry on a qualifying trade or the company ceasing to be independent) provided that the EMI Option is exercised within 90 days (previously 40 days), or such shorter period as the option agreement may specify, and the option is exercised after 6 April 2013.
If an individual holds EMI and non-EMI shares, the relaxation to the ER requirements only apply to the EMI shares.
- The proposed changes in legislation mean that in cases where the ER conditions would not otherwise be met, an EMI option scheme will be more tax efficient for the employee than a direct purchase of shares in the employing company.
- An EMI option scheme is a tax efficient way of incentivising employees without an impact on overheads and cashflow, it also gives the employee an added incentive in the long term success of the company.
- An EMI option scheme has a particular advantage for an employing company over a purchase of shares by an employee (in addition to the benefit to the individual of the relaxed ER rules) because it allows an employer to have more control as to when the employee will become a shareholder and what targets (if any) the employee must achieve before they have the right to purchase shares.