This article is useful reading for employees, employers and advisers. It is divided into sections which explain each part of the legislation contained in Schedule 5 Income Tax (Earnings and Pensions) Act 2003. Note, we also have an article which introduces ‘employee share schemes’ which we suggest you read first.
The main piece of legislation referred to in this article is the Income Tax (Earnings and Pensions) Act 2003. We use the following abbreviations: ITEPA 2003 and Sch 5. This is by no means the only piece of legislation applicable. If you grant EMI Options, you may have to consider other laws and rules. For example, there may be company law and regulatory requirements to comply with. Send us a message to ask further advice.
This article contains information on:
What are Enterprise Management Incentives (EMIs)?
How EMIs work;
The share options;
Qualifying companies;
EMI terms explained.
What are Enterprise Management Incentives (EMIs)?
EMIs are tax advantaged share options for employees. They are designed to help small, higher risk companies recruit and retain employees who have the skills to help them grow and succeed. They are also a way of rewarding employees for taking a risk by investing their time and skills to help small companies achieve their potential.
How EMIs work
Tax advantaged share options with a market value of up to £100,000 may be granted to a qualifying employee of a qualifying company, subject to a total share value of £3 million under EMI options to all employees. The shares must be in an independent trading company that has gross assets of no more than £30 million.
In order to qualify the company must:
Be independent (company must not be controlled by another company);
Be trading in the UK (more than 50%);
Not have gross assets in excess of £30 million (this is measured at the time the option is granted and applies to the consolidated assets of the group where there is more than 1 company);
Have fewer than 250 employees (at the date of grant), and;
Not undertake certain excluded activities (e.g. dealing in shares, property development, provision of legal or accountancy services, shipbuilding, coal and steel production, etc.).
For an employee to be eligible to receive qualifying EMI options, they must:
Work for the company, or one of its group companies for at least 25 hours per week, or, if less, for 75% of their working time per week, and;
Not own more than 30% of the ordinary share capital of the company.
The grant of the option is tax-free and there will normally be no tax or National Insurance contributions (NICs) for the employee to pay when the option is exercised. There will normally be no NICs charge for the employer, making EMI share schemes very easy to set up.
If the shares are sold at a gain, any capital gains tax (CGT) charge may be reduced because taper relief will normally start from the date that the option is granted.
The employer must notify HMRC of an award of EMI options within 92 days of the grant of the option.
How options qualify for tax relief under EMI
If an option is to qualify for tax relief:
The option has to be notified to HMRC in time and as required;
The company whose shares are under option has to be a qualifying company;
The type of share under option has to qualify;
The employee has to be eligible, and;
The terms of the option have to qualify;
The share options.
This section outlines the main requirements for options to qualify under EMI, they are:
The purpose of the option;
The maximum entitlement of the employee, and;
The overall limit on options to be granted by the company.
The purpose of the option
The options must be granted for commercial reasons to recruit or retain employees in a company, and not as part of an arrangement one of the main purposes of which is to avoid tax. (Para 4 Sch 5).
Maximum entitlement
No employee may hold unexercised qualifying EMI options with a market value of more than £100,000. The market value is taken at the date of grant of the option. If an option granted to an employee causes the £100,000 limit to be exceeded, the excess will not qualify as an EMI option.
How are shares valued for the purposes of the £100,000 limit?
The market value of any shares for this purpose is the price they might reasonably be expected to fetch on the open market, free from any restrictions or risk of forfeiture to which they may be subject.
If the shares under option are quoted on the London Stock Exchange, the market value is based on the prices on the Stock Exchange’s Daily Official List. If shares are not quoted on the London Stock Exchange, the company may offer its own valuation. In that case, HMRC may enquire into the valuation.
If the exercise of the option is subject to performance conditions will this affect the determination of market value?
No, since performance conditions are not taken into account when determining the market value of the shares under option.
Qualifying Companies
This section sets out the conditions a company has to meet to qualify for EMI, they are:
Independent;
Having only qualifying subsidiaries (including qualifying property managing subsidiaries after 17 March 2004);
Gross assets;
Trading activities.
The requirements that companies have to meet for options to qualify under EMI are similar to the requirements for the Enterprise Investment Scheme, the Corporate Venturing Scheme and Venture Capital Trusts. However, both quoted and unquoted companies can qualify for EMI.
Independent
A company whose shares are subject to EMI options must be independent – that is, not being:
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).
Qualifying subsidiaries (before 17 March 2004)
For options granted before 17 March 2004, all of a company’s subsidiaries must be qualifying subsidiaries. That is, the company whose shares are subject to EMI options must:
Possess, directly or indirectly, at least 75% of the share capital and the voting power of the subsidiary;
Be entitled to receive at least 75% of the assets of the subsidiary, in the event of a winding up or in any other circumstances, if they were all distributed;
Be entitled to at least 75% of profits of the subsidiary available for distribution to shareholders.
Qualifying subsidiaries (after 17 March 2004)
For options granted on or after 17 March 2004 all of a company’s subsidiaries must be qualifying subsidiaries. That is, the company whose shares are subject to EMI options must hold, directly or indirectly, more than 50% of the share capital of the subsidiary.
Qualifying property managing subsidiaries
For options granted on or after 17 March 2004, a company will not qualify if it has a property managing subsidiary which is not a 90% subsidiary of the company. A property managing company is one whose business consists wholly or mainly in the holding of managing of land, buildings or interest in land.
Gross assets
The value of the company’s gross assets must not exceed £30 million at the date the EMI option is granted. If the company is a member of a group of companies, the limits are applied to the gross assets of the group as a whole.
Trading activities
A qualifying trade is a trade carried on wholly or mainly in the UK on a commercial, profit making basis, and which does not, to any substantial extent, include certain excluded trading activities, listed later in this section.
Carrying on research and development from which a qualifying trade will be derived, or benefit, is treated as carrying on a qualifying trade (but preparing to carry on research and development does not count as preparing to carry on a qualifying trade). The derived or benefiting trade must be carried on by the same company, or by another company in the same group.
Research and development means activities that are treated as research and development in accordance with normal accounting practice, but excludes oil and gas exploration or appraisal.
Single companies
If a company is not a member of a group it must exist (apart from any incidental purposes) wholly for the purpose of carrying on one or more qualifying trades. It must also be either carrying on a qualifying trade, or preparing to do so.
Parent companies
Where the company is the parent of a group, the business of the group must not consist to any substantial extent of carrying on activities other than qualifying activities. At least one company in the group must meet the same conditions as those described for the single companies.
Excluded trading activities
A trade will not qualify if one or more excluded activities together amount to a substantial part of it. 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, such as a guest house or hostel, 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.
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. This exception does not apply to oil rigs or pleasure craft.
The trade or activity must be carried on wholly or mainly in the United Kingdom.
What if a company goes into receivership or liquidation?
Where a company is in administration or receivership, it is not regarded as ceasing to meet the trading activities requirements because of actions taken as a consequence of this. This is subject to the actions being taken for commercial reasons, not as part of a scheme of arrangement for the avoidance of tax.
EMI terms explained
Term
Definition
CSOP option
A Company Share Ownership Plan (CSOP) option granted to an individual under the provisions of
Schedule 4 ITEPA 2003
Disqualifying event
An event which results in an option ceasing to be an EMI option qualifying for relief
EMI option
An Enterprise Management Incentive option granted to an individual under the provisions of Schedule 5 ITEPA 2003
Employer
The company employing the individual to whom options are granted under the EMI option
Qualifying company
A company, which satisfies the requirements of Part 3 of Schedule 5 ITEPA 2003
Qualifying subsidiary
A subsidiary, which satisfies the requirements of Part 3 of Schedule 5 ITEPA 2003
Qualifying trade
A trade, which satisfies the requirements of Part 3 of Schedule 5 ITEPA2003
Recognised Stock Exchange
A stock exchange designated as a recognised stock exchange by order of HMRC under Section 841(1) (b) Income and Corporation Taxes Act 1988
Schedule 5
Schedule 5 Income Tax (Earnings and Pensions) Act 2003
If by chance you find some error of law or fact in any Net Lawman information page, do please tell us. We should also welcome your suggestions for new subjects for information pages. These notes:
Do not provide a complete or authoritative statement of the law;
Do not constitute legal advice by Net Lawman;
Do not create a contractual relationship;
Do not form part of any other advice, whether paid or free.
