Companies of all sizes set up employee share option scheme to incentivise their employees to meet certain performance targets or to attract talented workers. The contractual terms of how Share Options – or simply Options – are granted and exercised are usually set out in an option agreement. As a general rule, the employer grants all or some of its employees the right to buy certain number of shares in that company (or in a member of the same group of companies) at some point in the future for a fixed price.

An Option granted under a non-tax-advantaged scheme attracts income tax and national insurance contribution (NIC) on the value of the shares. However, an Option granted under a scheme that complies with certain statutory rules will carry advantageous tax treatment for both the employer and the employee. The HMRC has approved four tax-advantaged share incentive schemes, one of which is Enterprise Management Incentive (EMI). The purpose of the EMI scheme is to help higher risk and small companies to recruit and retain employees by offering them tax-beneficial share options.

Options offered at market value under the EMI Scheme can be granted and exercised free of income tax and NIC, provided that certain statutory requirements are satisfied. Some of the requirements must be met only at the time of grant of the EMI Options whilst others must be fulfilled until the EMI Option is exercised. Failing to meet a statutory requirement is a disqualifying event and can have an adverse effect on the option holder’s tax position.

EMI option scheme requirements

Broadly speaking, the requirements can be split into four categories as follows:

• the terms of the Option have to qualify for the EMI scheme;
• the type of shares that are issued following the exercise of the Option have to qualify for the EMI scheme;
• the company whose shares are the subject matter of the Option has to be a qualifying company; and
• the employee who receives the grant has to be an eligible employee.

The terms of the Option must be set out in a written option agreement and contain fundamental details such as the maximum number of shares under the Option. This is important because an employee must not hold unexercised EMI Options that have a market value of more than £120,000.00. It is also worth highlighting in the option agreement that the grant of the EMI Option is for commercial reasons only and not as part of a tax-avoidance arrangement.

The type of shares under the Option has to be ordinary shares in order to qualify under the EMI scheme.

The following key conditions must be fulfilled by the company in order to qualify for the EMI scheme:

• The company must be independent of other companies which means it cannot be a subsidiary of another business that owns more than 50% of its ordinary share capital or is controlled by another company.
• At the time of the grant, the company’s gross assets must not exceed £30 million, and the company must have fewer than 250 full-time employees or its equivalent.
• The company must be a trading company or the parent company of a trading group. Some activities, such as banking, insurance, moneylending, farming or market gardening, shipbuilding, and the supply of legal and accounting services will not qualify as trading for the EMI scheme purposes.

It is worth noting that EMI Options can be granted over the shares of a company that is incorporated outside the United Kingdom provided that the foreign company has a permanent establishment in the United Kingdom and meets the above conditions.

The key requirements that must be fulfilled by the relevant employee to be eligible to receive EMI Options are as follows:

• The employee must work at least 25 hours per week for the company (or the subsidiary, if applicable) or if less, then at least 75% of their working time should be spent at the company.
• The employee must not own (either alone or together with their associates) more than 30% of the ordinary share capital of the company.

The statutory requirements set out above is not an exhaustive list. If you decide to set up an EMI option plan, we recommend that you seek legal advice to fully understand the rights and mechanisms shaping the EMI option plan as well as the statutory criteria and the disqualifying events. Our team can help you design your preferred plan and obtain HMRC’s advance assurance to confirm that your company qualifies to grant EMI options.