This webiste provides information how vesting works, why it is important in the context of ESOP and VSOP as well as different types
Dominik Konold CEO/founder of Findiy GmbH, specializes in banking and corporate finance. With a background in audit and investment banking, he's a certified Professional Risk Manager and also serves as a lecturer in banking and accounting.
Enterprise Management Incentive Scheme
The Enterprise Management Incentive (EMI) is a government-backed share options scheme that provides companies with an efficient means to reward, retain, and incentivize key employees. It is highly tax-efficient for both businesses and employees, making it one of the most popular schemes for small and medium-sized businesses in the UK.
Designed by the UK government to help businesses grow, the EMI scheme is particularly attractive to companies with high growth potential, providing significant tax benefits compared to other share plans. This makes EMI an essential tool for startups and SMEs looking to compete with larger firms in attracting and retaining top talent
EMI Scheme Eligibility Criteria
For a company to qualify for the EMI scheme, it must meet several criteria set by HM Revenue and Customs (HMRC). Here are the main conditions:
Size and Structure
The company must have fewer than 250 full-time equivalent employees.
The company’s gross assets should not exceed £30 million.
It must be independent, meaning it should not be controlled by another company.
Permanent Establishment
The company should have a permanent establishment in the UK.
Qualifying Trade
The company must be involved in a qualifying trade. Certain industries, such as banking, legal services, and property development, are excluded from the scheme. Companies in these fields are not eligible to participate.
In addition to company qualifications, there are also specific requirements for employees. To receive tax-favorable EMI options, employees must:
- Work at least 25 hours a week or dedicate at least 75% of their total working time to the business.
- Not hold more than 30% of the company’s share capital.
- Not have EMI options valued at more than £250,000 in a three-year period.
Benefits of EMI Scheme
The EMI plan is widely regarded as the most tax-efficient share plan available in the UK. Both employers and employees can reap substantial benefits through the plan.
For Employers
- No National Insurance Contributions (NICs): There are no NIC liabilities when granting options. Tax Deductions: Employers can claim corporation tax relief on the difference between the market value and the strike price of shares when options are exercised.
- Attraction and Retention: EMI options help companies attract and retain talented employees by providing them with a stake in the company’s success.
For Employees
- No Tax on Grant or Exercise: Employees do not pay income tax or NIC when options are granted or exercised, as long as the exercise price is not below market value.
- Lower Capital Gains Tax (CGT): Upon the sale of shares, employees are eligible for Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief), which allows them to pay a reduced CGT rate of 10% on the first £1 million of capital gain.
How the EMI Option Scheme Works
The EMI scheme allows businesses to grant employees the right to buy shares in the company at a future date and at a price agreed upon when the options are granted. The following steps outline how the EMI scheme typically operates:
1. Setting up the Plan: Before granting EMI options, a company must set up an plan. This plan will outline the rules and parameters of the share options, including:
- The class of shares to be granted as options.
- Vesting periods and performance conditions.
- The conditions under which employees can exercise their options (e.g., after meeting certain performance metrics or reaching a length-of-service milestone).
2. Obtaining a Valuation from HMRC: One of the most important aspects of setting up an EMI scheme is obtaining a valid valuation from HMRC. This step ensures that the strike price (the price at which employees can buy shares) is aligned with the market value of the shares at the time the options are granted. Securing “pre-clearance” from HMRC mitigates future tax risks by ensuring the exercise price is not challenged down the line.
3. Granting Options: Once the plan is adopted, companies can begin granting share options to eligible employees. The total value of options granted under an EMI scheme must not exceed £3 million across all employees, and no single employee can be granted options worth more than £250,000.
4. Vesting and Exercising Options: Vesting periods can be tailored to the company’s specific needs, allowing for flexibility in when employees can exercise their options. Options must be exercisable within 10 years of being granted, and companies can impose conditions such as performance milestones or length-of-service requirements.
5. Exiting the Scheme: Employees can exercise their options and sell their shares either upon hitting specified targets or during an exit event, such as a company sale or merger. If the employee leaves the company, they may need to exercise their options within 90 days to maintain their favorable tax treatment.
Tax Implications of the EMI Share Plan and EMI Valuation
The tax benefits of the EMI scheme are a significant reason for its popularity. Both businesses and employees enjoy generous tax benefit under this scheme:
For Employers
- Corporation Tax Relief: Employers can claim corporation tax benefit on the difference between the market value of the shares at the time of grant and the price at which the employee exercises the options. This relief can substantially reduce the company’s overall tax burden.
For Employees
- Capital Gains Tax: When employees sell their shares, they pay CGT on any gains. However, because EMI shares are eligible for Business Asset Disposal Relief, employees pay a reduced CGT rate of 10% on the first £1 million of gain, provided they hold the options for at least 24 months before selling the shares.
- No Income Tax or NICs: As long as the strike price of the EMI options is at or above the market value at the time of grant, employees do not pay income tax or NICs when the options are granted or exercised.
How to Set Up an EMI Scheme
Setting up an EMI scheme can be a complex process, and it’s advisable to work with professionals to ensure compliance with HMRC regulations. Below are the key steps in setting up an EMI scheme:
1. Prepare a Plan: Develop an EMI share plan that outlines the terms of the scheme, including eligibility criteria, vesting periods, and performance conditions.
2. Get Valuation Approval from HMRC: Secure HMRC approval for the company’s valuation to ensure that the exercise price of the options is in line with the market value of the shares.
3. Adopt the Plan: The plan must be adopted by the board of directors and may require shareholder approval, depending on the company’s constitution.
4. Notify HMRC: Once the EMI options are granted, the company must notify HMRC within 92 days to ensure the tax advantages of the scheme are preserved.
Managing an EMI Scheme
Conclusion
The Enterprise Management Incentive (EMI) scheme is a powerful tool for small and medium-sized businesses in the UK, offering significant tax benefits to both employers and employees. By setting up an EMI scheme, companies can attract, retain, and motivate key talent while rewarding employees with a stake in the company’s success. If structured and managed properly, the EMI scheme can be a vital component of a company’s growth strategy, enabling it to compete for talent and incentivize long-term commitment.
For businesses considering an EMI scheme, it’s essential to work closely with legal and tax professionals to ensure compliance with HMRC regulations and maximize the benefits of this highly favorable plan.