Enterprise Management Incentives (EMI) option schemes offer valuable tax benefits, but they come with strict rules. Companies often make mistakes when setting up these schemes, which can lead to disqualification or unexpected tax bills.
Qualifying Companies and Share Classes
To offer EMI options, your company must be a trading company with gross assets under £30 million and fewer than 250 employees. Many businesses fail to meet these requirements without realising it. For example, if your company holds significant investments alongside trading activities, it might not qualify. To qualify for EMI tax relief, a company must engage in a qualifying trade, as certain activities like leasing and financial services are explicitly excluded. Enterprise management incentive schemes are crucial in meeting these eligibility criteria and ensuring compliance.
The shares used for EMI options must be fully paid, ordinary shares. A common mistake is using shares with restricted rights. Your EMI shares must give employees the same rights to dividends and voting as other ordinary shareholders.
Another pitfall is granting options too close to a company sale. HMRC requires options to be held for at least 24 months to receive full tax benefits. This timing issue often surfaces during exit negotiations.
Employee Eligibility Requirements
Employees must work at least 25 hours per week for your company or spend 75% of their working time with you to be considered a qualifying employee. They cannot hold more than 30% of your company’s shares when granted options.
Employees with a material interest of over 30% in the share capital are not eligible for EMI options.
Many companies mistakenly include contractors or consultants in EMI schemes. Only employees with proper employment contracts qualify. Directors are eligible if they meet the working time requirements, unless they also have material interest in the share capital.
A frequent oversight is failing to update EMI arrangements when circumstances change. If an employee reduces their hours or takes extended leave, they may no longer qualify. Regular reviews of eligibility can prevent this issue.
Always document option grants properly. Missing paperwork or failing to notify HMRC within the stipulated timeframe may invalidate the tax advantages of your EMI scheme.
Common Pitfalls in EMI Scheme Implementation
Many businesses struggle with EMI schemes due to specific technical challenges that can lead to tax benefits being lost. Understanding these pitfalls is essential to ensure your EMI options work as intended. It is crucial to understand the criteria and conditions under which EMI options are granted to avoid common pitfalls. Adhering to EMI scheme rules is crucial to avoid common pitfalls and ensure compliance with HMRC regulations.
Failure to Meet Eligibility Throughout the Option Period
HMRC requires stringent eligibility conditions for EMI schemes that must be maintained throughout the option period. You must ensure your company remains a qualifying company with gross assets under £30 million and fewer than 250 employees.
One common issue is failing to monitor the working time requirement. Option holders must spend at least 25 hours per week or 75% of their working time on company business. If an employee reduces their hours or takes extended leave, their EMI status could be compromised.
Another frequent mistake is not keeping proper documentation. HMRC guidance suggests maintaining evidence of valuations, board minutes approving the scheme, and notifications to HMRC. Without these records, your scheme may fail HMRC scrutiny during an exit or sale process. Additionally, disqualifying events can impact eligibility and tax benefits, making it crucial to understand and manage these events to maintain the advantages of the EMI scheme.
Dilution and Impact on Existing Shareholders
When implementing an EMI scheme, you must consider how it affects existing shareholders. The creation of an option pool dilutes current shareholdings, which can cause tension if not properly communicated. Additionally, unlisted companies need to address specific considerations such as obtaining prior agreement on the market value of shares and securing advance assurance from HMRC to ensure compliance and maintain the tax-favored status of the options.
Options can be granted over shares in the parent company, provided that at least one trading subsidiary is engaged in a qualifying trade.
You should obtain shareholder approval before implementing your EMI scheme. Many companies fail to secure proper consent, leading to disputes when options are exercised. This is particularly problematic during funding rounds or company sales.
The size of your option pool requires careful consideration. Too small, and you’ll struggle to recruit key talent. Too large, and you risk excessive dilution of existing shareholders. A typical option pool ranges from 10-15% of share capital.
Remember to clearly define what happens to options during funding rounds. Without proper anti-dilution provisions, option holders may find their potential equity stake significantly reduced.
Inadequate Onboarding Process and Communication
Poor communication about EMI schemes often leads to misunderstandings and disappointed employees. You must develop a clear onboarding process that explains how options work and what employees can realistically expect. Providing the necessary legal documents during this process is crucial to ensure employees are fully informed.
Many companies fail to explain the difference between having options and being a shareholder. Employees frequently don’t understand they won’t receive dividends or voting rights until they exercise their options.
You should provide written materials that clearly explain exercise conditions, vesting schedules, and tax implications. Complicated schemes without proper explanation can reduce the motivational impact of your EMI scheme.
Another pitfall is not addressing what happens if an employee leaves. Your option agreements should clearly define ‘good leaver’ and ‘bad leaver’ provisions so there’s no ambiguity about option treatment upon departure.
Best Practices for Successful EMI Scheme Management
Managing an EMI scheme effectively requires attention to detail and compliance with HMRC regulations. The following practices will help you avoid costly mistakes and ensure your scheme delivers the intended benefits to your company and employees. Additionally, understanding EMI tax benefits is crucial for effective scheme management, as these benefits come with specific conditions that must be met to qualify.
Robust Documentation and Record Keeping
Maintain comprehensive documentation of your EMI scheme from day one. This includes share plan rules, option agreements, board minutes approving the scheme, and valuation documentation. It is also essential to clearly define and maintain scheme rules to ensure compliance with HMRC guidelines and to maintain beneficial tax treatment.
The date of grant is crucial for determining tax implications and must be reported to HMRC promptly to ensure compliance.
Store all HMRC correspondence in a dedicated file, particularly the valuation agreement letter. This will be crucial if HMRC conducts a compliance check in the future.
Track option holders’ details in a secure register, including grant dates, exercise prices, and vesting schedules. Consider using specialised software solutions for larger schemes to avoid spreadsheet errors.
Set calendar reminders for annual EMI returns, which must be submitted to HMRC by 6 July following the tax year end. Late submissions can trigger penalties starting at £100 and increase with further delays.
Review your documentation annually to ensure it reflects any changes to your business structure or employee circumstances. This proactive approach prevents issues during due diligence if you seek investment or plan an exit.
Proactive HMRC Engagement and Compliance Checks
Establish open communication with HMRC from the outset. Submit your company valuation for approval before granting options to ensure tax advantages apply. Seeking professional advice can be crucial in navigating the complexities of EMI schemes and ensuring compliance with all necessary requirements.
Notifying HM Revenue and Customs (HMRC) about the grant of EMI share options within the required timeframe is essential to retain tax benefits.
Consult HMRC guidance regularly as rules change. The gov.uk website provides updated information on EMI schemes, including eligibility criteria and reporting requirements.
Consider appointing a dedicated person (often the CFO or CTO) to manage HMRC relationships. This ensures consistent communication and builds institutional knowledge.
Be prepared for HMRC compliance checks by maintaining audit-ready documentation. If HMRC contacts you, respond promptly and comprehensively.
Conduct annual internal audits of your EMI scheme to verify continued compliance with qualifying conditions. This includes checking that option holders still meet the working time requirement (at least 25 hours weekly or 75% of working time).
Schedule regular reviews with your advisers to adapt your scheme as your company grows. Your EMI may need adjustments as you approach the £30 million gross asset limit or if you plan international expansion.
Taxation, Reliefs, and Legal Compliance in EMI Schemes
EMI schemes offer significant tax advantages, but they require careful navigation of complex tax rules and compliance requirements. Proper implementation ensures these benefits are fully realised while avoiding costly mistakes. EMI schemes are regarded as the most tax efficient option compared to other share option schemes available to UK businesses. Additionally, corporation tax relief can significantly benefit employers by providing financial gains when shares are exercised, especially during a sale.
Income Tax and National Insurance Contribution Issues
When implementing EMI schemes, you must understand the income tax implications. Properly structured EMI options typically don’t trigger income tax or National Insurance Contributions (NICs) when granted. This contrasts with non-tax advantaged options where employees might face immediate tax liabilities.
Additionally, employers benefit significantly as they incur no employer’s national insurance contributions when granting share options, alleviating immediate tax burdens and contributing to potential corporation tax relief.
You should ensure options are granted at market value to avoid income tax charges. If options are granted at a discount, the difference may be subject to income tax and NICs.
When options are exercised, you’ll generally avoid income tax and NICs if the exercise price is at least equal to the market value at grant date. This represents a significant advantage over non-qualified schemes.
Common mistakes include:
- Failing to notify HMRC of granted EMI options
- Not maintaining proper documentation of valuations
- Missing annual returns (EMI40) deadlines
Capital Gains Tax and Business Asset Disposal Relief
When employees sell shares acquired through EMI options, they’ll typically pay Capital Gains Tax (CGT) on any gain. The major benefit is that these gains often qualify for Business Asset Disposal Relief (BADR, formerly Entrepreneurs’ Relief).
EMI schemes offer generous tax advantages, including reduced Capital Gains Tax rates and Business Asset Disposal Relief.
BADR reduces the CGT rate from 24% to 14% on qualifying gains up to £1 million over your lifetime. For EMI options, the standard two-year holding period requirement is modified – the period between grant and disposal must be at least 24 months. Understanding the implications of EMI tax treatment is crucial for maximising these tax benefits.
You must ensure employees understand these conditions:
- They must be an employee throughout the option-holding period
- The company must be a trading company or holding company of a trading group
Failing to meet these conditions can result in higher tax rates and missed relief opportunities.
Our EMI Scheme Support
At Plus Accounting, we offer comprehensive support for your EMI share scheme implementation. We understand the complexities involved and work to help you avoid common pitfalls. EMI schemes are an effective way to reward employees while also benefiting from tax offsets.
Our team provides guidance through the entire EMI process – from initial planning to implementation and ongoing compliance. We ensure your scheme meets all HMRC requirements to maintain tax advantages.
We assist with:
- Determining company and employee eligibility
- Valuation negotiations with HMRC
- Reviewing option agreements
- Completing necessary notifications within deadlines
- Ongoing administration and reporting
Our experts help you navigate the technical aspects of EMI schemes, including the often-overlooked tax valuation process. Though not strictly required, having an HMRC-agreed valuation can provide certainty for your scheme.
We also support effective communication with your employees about their EMI options. Clear explanations of the benefits and conditions help ensure your team understands and appreciates the incentive.
Regular scheme reviews are part of our service. We monitor changes in legislation that might affect your EMI arrangements and advise on necessary adjustments.
With our support, you can implement an EMI scheme that effectively incentivises key staff while maximising tax advantages. Our goal is to help you use EMI schemes strategically to support business growth and retention of valuable team members.
Talk to us for advice on how to best make use of EMI schemes.