EMI is an employee share option regime that gives early-stage trading companies a way to recruit and retain the high-calibre staff they need to grow, without a significant upfront cash outlay.
EMI was first introduced in 2000, but its popularity as a method of remuneration continues to grow. In the 2019/20 tax year, approximately 39,000 employees were granted EMI options, and there were almost 14,000 live EMI plans in operation.
EMI arrangements are hugely popular in the technology sector and have become almost market-standard for senior hires into early-stage tech companies. However, we find that many entrepreneurs and employees are still not entirely comfortable with how EMI options work in practice.
In this article we therefore run through the basics of EMI option plans and how they work in practice. Readers keen to know more about EMI may also wish to consult our recent Spotlight on… EMI article.
Option schemes – the basics
An employee option plan is an arrangement in which an employer company gives one or more of its employees the opportunity to obtain shares in the company if certain conditions are met.
Sometimes senior employees are given the opportunity to become full shareholders in the business, the idea being to incentivise them through ongoing ownership. However, in most cases, the option-holders will not become ongoing shareholders: they will only obtain shares in the event the company is sold, meaning they that have the chance to participate in any profit on disposal, if they remain employed for that long.
There are a number of concepts that are key to understanding how employee share options work.
- An option is a right to acquire a given number of shares at a predetermined price, typically in the future once certain conditions are met. Options are said to be granted to employees when the employees receive them. The grant of options involves the signing of an option agreement between the employee and the company.
- The price that will be payable per share is called the exercise price and is fixed upfront. It is ordinarily equal to the current market value per share at the date the options are granted.
- The grant of options does not mean that the employee owns shares in the company – this only happens once the options are exercised. To exercise the options, the employee notifies the company that they wish to do so and pays for the shares, which are then issued to the shareholder.
- Typically, the exercise of options is conditional on meeting certain performance conditions or on passage of time. When options become exercisable, they are said to vest; the period over which they become exercisable is called the vesting period.
- Options will often vest in tranches over a period of time by reference to a pre-determined vesting schedule (for example, a quarter of the options might vest at the end of each of the first four years of ownership).
- Sometimes the option agreement will allow the options to vest automatically in certain situations, such as a sale of the company, notwithstanding the normal vesting schedule. This is known as accelerated vesting.
How are EMI options beneficial from a tax purposes?
When an employee exercises share options, they pay cash (the exercise price) and receive shares. Generally, the value of the shares at the exercise date will exceed the exercise price, so the employee receives an employment benefit equal to the difference.
As a general rule, therefore, employees are subject to Income Tax on any value provided to them by their employer. So, where an employee exercises non-EMI options, they will be subject to Income Tax on the difference between the value of the shares they receive and the exercise price they pay. Income Tax is usually charged at 40% or 45% in such cases. When the employee comes to sell their shares, they will be subject to Capital Gains Tax (CGT) on the proceeds they receive, less the market value at exercise. CGT is typically charged at 20%.
For options that qualify under the EMI regime, there is no Income Tax charge at exercise. Tax only arises when the shares are sold, at which point the full difference between the sale proceeds and the original exercise price is subject to CGT at 20% – or 10% if the options were granted at least two years before the sale. This provides a far better tax outcome for the employee.
How do I set up an EMI scheme?
EMI schemes can often be established within two or three months.
The first step is to determine whether the various conditions for EMI are met. If they are, then consideration should be given to the design of the scheme. Management will need to consider which employees will be granted options, how many options each will receive, whether the options should be over shares with specific rights that differ to the shares already in issue, the vesting conditions / schedule, whether accelerated vesting provisions apply, and so on.
As noted above, the exercise price is set equal to the market value of the shares at the grant date. It is generally necessary to undertake a valuation of the shares for tax purposes, which is then submitted to HM Revenue & Customs (HMRC) for approval in advance of the grant of options. This provides a degree of reassurance over the tax position for employees.
If the scheme is not implemented correctly, there is a risk that the intended tax benefits may not arise, and that unexpected tax liabilities could materialise. The option grant documentation should therefore be prepared by suitably experienced lawyers, although it is typical for tax advisers to review this before it is finalised.
Once EMI options have been granted, the EMI scheme must be registered with HMRC (via an online portal) and the grant of options must be registered with HMRC within 92 days. Annual returns, reporting any events associated with the scheme, must be submitted to HMRC by 6 July each year.
The company’s circumstances should be monitored on an ongoing basis, to ensure that no events arise that could compromise the EMI status of any unexercised options.
If you have any questions in relation to this article or would like to discuss EMI arrangements – or other tax-efficient ways of incentivising staff without a significant cash outlay – please speak to your usual Blick Rothenberg contact or get in touch with one of our experts below.
 National Statistics: Employee Share Schemes statistics, Tables 6 & 8, https://www.gov.uk/government/statistics/employee-share-scheme-statistics (retrieved 11 October 2021).
Would you like to know more?
Please contact a member of our technology team, your usual Blick Rothenberg contact, or Robert Harness, using the details on this page, if you would like to discuss this further.