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The Enterprise Management Incentive (EMI) has, for a long time, been the most favoured share option arrangement for UK employers in trading companies to introduce to selected numbers of its qualifying employees, writes our Head of Tax Cormac Marum.
Provided the company qualifies, EMI allows options to be granted to selected numbers of qualifying employees, who must not already hold more than 30% of the shares in the company but must work, and continue to work until exercise, for generally at least an average of 25 hours for the issuing company or a group subsidiary company.
With an EMI option, the employee can be asked to pay on exercise (at some point within the next 10 years) at least the current market value set at the date of grant of the shares subject to the option and pay no income tax on that exercise and (provided the option was granted at least a full two years before the shares are sold) just 10% capital gains tax on the gain made on disposal.
Most commonly, the EMI option is exercisable only on an ‘exit event’, such as the eventual sale of the company, so that, in practice, the employee never has ‘to put their hand in their own pocket’ as their exercise price is deducted from their sale proceeds received later the same day.
It is hoped this incentive will encourage the key employee to work to build up the value of the company toward a successful ‘exit event’.
From the outset under EMI, it has been a requirement that the option agreement between employer and employee has to be written down before the option is granted. The legislation has made clear that the written agreement must state:
• The date on which the option is granted
• That it is granted under the EMI legislation rules
• 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 option may be exercised.
These conditions are not onerous and involve no employer discretion after the date of grant.
But sometimes employers introduce conditions, often relating to the employee’s personal performance, affecting the terms and the extent of that employee’s entitlements to EMI options. These can introduce a degree of employer discretion and have led to a potential problem.
In the exercise of employer discretion has the existing option been discarded and replaced by a new option?
This matters because, if the employee is to pay no income tax, the exercise price on the new option must be no lower than the market value of the shares on the date the new option is granted and the two year ‘clock’ restarts to qualify for the 10% capital gains tax on eventual sale of the EMI shares.
In its October 2022 Bulletin, HMRC has reiterated the position that the written agreement must be in place in accordance with the EMI legislation and contain any performance conditions therein. Those performance conditions cannot be amended afterwards. To do so would annul the original option and create a fresh EMI option.
A fresh EMI option may need a new exercise price if the employee is going to pay no income tax on exercise and, with a fresh EMI option, the two year ‘clock’ restarts for the employee to earn the 10% capital gains tax on eventual sale of the EMI shares obtained.
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