EMI Share Options: Why are they so popular and the key pitfalls

EMI share options are a cost-effective way to motivate and encourage key employees to help grow the business, such that everyone benefits on an exit event.

Properly drafted, EMI share options, allow for no cost upfront for the employee, with the employee only having to pay a low price for the share on an exit event, moments before the sale proceeds are received. The low price can be agreed with HMRC at the time the option is granted, often, several years before an exit event. The resulting gain from the date the options are granted to the date of exercise is taxed as a capital gain, currently at 10% (assuming the conditions for Business Asset Disposal Relief {BADR} are met), a far more favourable tax rate than a cash bonus (at up to 45% income tax).

What could possibly go wrong?

The tax benefits of EMIs can quickly be lost if all the conditions, rules and HMRC filing requirements are not met, resulting in the options becoming “non-tax advantaged”.

Example

An employee is granted options in May 2018 over 1% (10,000 shares) of the company. The market value agreed with HMRC at the time of grant is £1 per share, which is also the exercise price in this example. The market value at the date of exercise, May 2020, is £20 per share. The sale price in May 2022 is £32 per share.

Tax	EMI	Non-tax advantaged share option scheme
On grant	0%	0%
On exercise	0% – if market value at date of grant is paid. Exercise in many cases occurs several years later and the growth from grant to exercise is “tax free at this stage”.   Employee pays £10,000 for the shares.	Up to 45% on the market value at the date of exercise minus the amount paid for the share.    Employee pays £10,000 for the shares.   Employee pays £85,500 in tax (£200,000 – £10,000) X 45% (assuming additional rate taxpayer)
On sale of shares	10% on sale price minus market value at date of grant (assuming BADR* applies)   £31,000 (£320,000 – £10,000) X 10%	20% ** on sale price minus market value on exercise.    £24,000 (£320,000 – £200,000) x 20%
Total cost to employee	For shares – £10,000   Tax – £31,000	For shares – £10,000   Tax – £109,500

How could my options become non-tax advantaged?

Options drafted to be under the EMI scheme will automatically become non-tax advantaged if any of the conditions, rules or HMRC notification are not met.

Pitfalls to look out for

Disqualifying events

There are various disqualifying events that will remove tax relief for EMI purposes. The events may relate to the company, the employee, the options or the shares to which they relate. Some of these are discussed below. EMI tax relief is lost if the option is exercised more than 90 days after a disqualifying event such that the gain arising between the disqualifying event and the date of exercise is taxed in the same way as for a non tax-advantaged share scheme.

The company’s/group activities are non-qualifying

Whilst most trading activities conduced with a view to a profit qualify, there are a number of activities that are non-qualifying. The company/group could cease to meet the trading activities requirement.

Working time condition

If an employee’s relevant working time does not reach 25 hours per week or, if less, 75% of their ‘working time”, the employees working time condition will cease to be met.

The employee will also cease to be an eligible employee if his employment terminates.

Variation in the option terms

A variation in the option terms may either increases the market value of the shares subject to the option or mean that the requirements of the legislation are no longer met.

Independence

The EMI company becomes a 51% subsidiary of another company or comes under the control of another company.

Other pitfalls

Notifying HMRC

Companies operating EMI schemes are required to notify HMRC online of the grant of an EMI option within 92 days of the date of grant of the EMI option.  Failure by the company to do so is likely to result in the loss of the EMI tax status of the option.

Limit on options

The maximum value of tax-advantaged EMI options that can be granted is £250,000 per employee, which is reduced where the employee holds unexercised options granted under a company share option plan (CSOP) scheme.

Where the value of an employee’s options reaches £250,000, no further qualifying options can be granted for three years, even if some of the options have been exercised during that period.