Motivate, recover and grow – the benefits of EMI schemes
The business world as we know it has changed significantly over the past few months, so much so that there are many of us who anticipate it will never be the same again.
Many businesses are going through turbulent times and it has never been more important to motivate staff and ensure there is a collective effort to get the business back on track and grow.
Many employees are working from home or have been furloughed and therefore motivating and retaining talent, at a time when there may be limited cash resources, can be difficult.
The Enterprise Management Incentive (“EMI”) scheme is a government backed, tax advantaged share option scheme, designed to assist entrepreneurial businesses to retain and recruit high quality employees. They are often used by companies to reward and share success with key employees as the company grows.
There are tax benefits for the both the company and employee. The main tax advantages of the scheme compared to other unapproved schemes are very generous:
- no income tax or national insurance on grant,
- no income tax or national insurance on exercise (if the market value at grant is paid by the employee),
- capital gains tax on the sale of the option shares (usually at 10% providing the option grant date was at least 2 years before the sale), and
- the employing company will generally qualify for a corporation tax deduction for the difference between market value at exercise and price paid by the employee.
Share option schemes can be extremely motivating for employees, especially where share options are only exercisable upon achievement of targets. Option exercise may occur, for example, after a specified period of employment, or upon the achievement of performance targets, or upon the sale of the company. They can be structured in such a way to meet the company’s long term aims of recovery and growth.
An EMI scheme can be the perfect solution for smaller business who may not be able to match the salary levels of the larger competitors.
Who is eligible for an EMI scheme
The scheme is not available to all companies, (there are certain requirements regarding qualifying trades and size of the company) but generally EMI schemes are extremely flexible as to who can participate, and the performance conditions linked to the options.
EMI schemes are best illustrated in the fictitious example of SuperTech Ltd. Sam is granted an EMI option to acquire a 5% holding in SuperTech for its market value of £10,000. Sam and SuperTech part with no cash and have no tax to pay today.
Two years later Sam exercises her options and pays the agreed market value of £10,000, when the shares are worth £15,000. Sam and SuperTech pay no tax at this point but Supertech can claim a corporation tax deduction for the difference between the market value at exercise and the price paid by Sam. Sam is now a shareholder in the company and can share in dividends for her investment.
Four years later Sam sells the shares for £100,000 when the company is taken over. Sam pays capital gains tax on £90,000 (the difference between sale proceeds and option exercise price) and should benefit from the resulting gain being taxed at just 10% (where Business Asset Disposal Relief applies).
Valuing the shareholding today
The value of the shareholding should be approved by HMRC at the grant of the option.
Valuing companies can be complex, even more so in turbulent times. The impact of the pandemic on the stock markets has been widely publicised as values have significantly dropped in 2020. This is also likely to be the case for many private firms in the UK depending on their trade and therefore granting options in the current time could be tax efficient for companies.
The value of a shareholding is based on the future economic benefit to the purchaser which is even more uncertain for many private companies in the current time. The methodology for building the risk and uncertainty into valuations will be different for each company and requires careful consideration as not only are there many different valuation methodologies to be considered, but adjustment for COVID-19 could be made in a number of ways.
It is important that valuers do not rely on historic results if they are no longer indicative of the future. Thought and consideration will need to be given to how quickly the company is likely to recover and the increased risk in the current times.
Ultimately the valuation will be lower for many companies compared to pre COVID-19. In addition to heightened tax savings, this could also mean that companies who have previously not met the EMI qualification criteria due the company value being too high may now meet the criteria.
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