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For companies which are not listed on the main market and which have a physical presence in the UK, EMI options remain the most tax efficient way of incentivising employees. EMI options have always guaranteed broad tax benefits, in securing a capital gains tax treatment at 28%, provided various conditions are met. From 6 April 2013, the benefit of entrepreneurs’ relief, reducing the capital gains tax rate to 10% can apply to shares acquired pursuant to EMI options even if the option holder does not hold 5% of their employer and sells their shares after less than 12 months.
Enterprise Management Incentive (“EMI”) schemes are a popular means of incentivising employees in the UK through the provision of an option to acquire shares at a future date for a fixed price. Only certain classes of companies qualify to grant EMI options and the most pertinent qualifying conditions include:
Companies involved in certain trades are ineligible for EMI, but most companies in the energy sector should be eligible. In cases of any doubt, applications can be made to HMRC to confirm whether companies are eligible for EMI.
If the relevant conditions are met, participants in EMI schemes can benefit from favourable tax treatment. Broadly if the price at which the options can be exercised (i.e. the point at which options are converted into shares) is set at the market value of the shares at the date the option is entered into, any growth above this price will be subject to capital gains tax rather than income tax (and possible employer and employee Class 1 national insurance contributions).
Usually capital gains tax is paid at a rate of 28%. However entrepreneurs’ relief, which reduces that rate to 10% for the first £10m worth of lifetime gains, is available to employee shareholders who have held at least 5% of the shares in their employer for at least 12 months.
Since EMI schemes will typically only permit exercise upon an exit event, such as a company sale, often option holders will not hold their shares in their employer for 12 months (as they may be required to immediately sell their shares as part of the sale) and therefore will be restricted to the 28% rate.
Extension of Entrepreneurs’ Relief for EMI The new Finance Bill will extend entrepreneurs’ relief to EMI schemes from 6 April 2013 by relaxing the following conditions for EMI schemes:
The consequence is that even if the shares acquired under an option are immediately sold on following exercise, for example upon a company sale, the reduced rate of tax to 10% should apply provided the option has been in place for at least 12 months.
EMI has already long been recognised as the most tax efficient scheme for companies which qualify. The combination of Entrepreneurs’ Relief with EMI schemes could reduce the effective total rate of tax levied on the individual optionholder to 10%, as compared with up to 58.9% for other forms of incentive scheme. In addition to providing a greater incentive to employees, this could reduce the cost of remunerating employees, because the same net of tax position that employees could have achieved under the old rules could be achieved from 6 April 2013 by the grant of fewer options.
Companies that are currently considering implementing some form of incentive scheme should be aware of the proposed changes, as an EMI scheme may be a very tax-efficient way to motivate and retain key members of staff.
If any companies with EMI schemes in place are due to complete company sales prior to 6 April 2013, they may wish to consider deferring completion to after 6 April 2013 to ensure the benefit of the new rules can be obtained.