share options Archives - London Chartered Accountants Blog

The benefits of Enterprise Management Incentive (EMI) share option schemes were highlighted in Sarf Malik’s recent blog on incentivisation in the creative sector.

Tax efficiency

EMI are considered the gold standard of share option schemes and, if the qualifying conditions are met, are often the first choice for option incentivisation. This is because of the tax efficiency associated with the options.

Conditions of EMI schemes

EMI have conditions which must be satisfied by the company whose shares are being offered and have conditions which need to be satisfied by the employee who is being granted the options.

There are company conditions attached to the size of the company and its numbers of employees. These conditions are broadly designed to ensure that the company is within the SME sector. The company must have a connection with the UK and it is only the top company of a group which can issue the options. This does not prevent options being issued to employees of a subsidiary. The company must be a trading company and cannot undertake certain prohibited trades. The restriction on acceptable trades is to ensure that there is an element of risk associated with share ownership.

The purpose of the options must be to incentivise employees and there are conditions which ensure that the employee has reasonable employment duties and cannot have a connection with the company which allows more than a 30% ownership interest in it.

Benefit of EMI

The benefit of EMI is that capital growth can be subject to capital gains at a 10% rate of tax.

Ultimately this is the fiscal incentivisation for the option holder to exercise options. Assuming that the employee pays full market value for the shares (with that value being determined at the day the options are granted) then any growth between grant and exercise of the option is not taxed until the shares are sold. That growth, together with any further growth from holding the shares after exercise of the option, is subject to capital gains tax.

Share growth would be subject to a 10% rate of tax as shares arising from EMI options attract Bussines Asset Disposal Relief. This applies even if the options are not exercised until a time immediately prior to a company sale with many EMI plans are structured as being “exit only” to provide employees the ability to participate in a share sale.

Tailored solution

The terms of EMI options must be recorded in writing and this is an opportunity to provide conditionality on their exercise. Options can be tailored for individual employees and therefore provide targets which are under the control of the employee. For example a sales director may be able to exercise options if X leads are converted into customers within a timeframe or a member of the HR team might have the ability to exercise options once the head count exceeds Y employees.
Whatever the conditions attached for options they need to be able to be satisfied within ten years of grant of the option.

The Admin

Once options are granted there are administrative requirements to notify HMRC of their existence, both after their grant and annually thereafter. From an accounting perspective EMI options are included within the cost of employee rewards and there is annual accounting to determine how much reward should be charged to company accounts. As this accounting entry does not lead to tax relief until exercise of the option there are consequential deferred tax considerations.

In summary EMI options are often the first choice for incentivisation but they come with conditions, administration and accounting obligations.

Shares or share options are well known ways to incentivise employees and care is needed to review the tax considerations for these. However, this is far from the only consideration needed when looking at the best way forward for a family business.

It is quite common for the main shareholders of a private business to have conflicting emotions when incentivising key staff. On the one hand they understand the benefits of long term incentivising by offering equity in a company. However it is common for key management not to be members of the family which own the business and therefore there can be resistance to allowing shares to be offered to “outsiders”.

The psychological dilemma can be partially overcome by issuing phantom shares or share options. Phantom shares are bonus arrangements (subject to PAYE and National Insurance) which provide management with the same level of income as if they owned shares but without actually issuing them with shares. This allows management to feel that their efforts are rewarded without the owners giving away any of the business. Our clients have used these arrangements however, as payments are through the PAYE system they can be expensive for the employer.

Share options can be used to overcome the dilemma about loss of control by the family. We have had clients who have not been keen on issuing options for this reason. Their concerns have been alleviated when we point out that options can be granted which only vest on certain criteria eg on sale. This therefore allows the family shareholders to retain control until such time as there is an exit event. At that point the management participate and their hard efforts leading up to the sale can be rewarded.

Enterprise Management Incentive (EMI) options are the gold standard of option as they allow the option holder Business Asset Disposal Relief in most cases and most of our work is aimed at issuing EMI options where they are possible. There are various criteria attached to EMI options which need to be considered, including that the option must be capable of being exercised within ten years of grant. Occasionally there are discussions between shareholders and management about quantum of options offered to management. If it is over a fixed number of shares then management may have concerns that subsequent share issues would dilute their entitlement.

If the conditions attached to EMI cannot be met then a Company Share Option Plan (CSOP) may be appropriate. This can be used by any company regardless of its type of trade or size. This type of approved option has a £30,000 monetary limit on the value of equity per employee with the requirement for the options to be exercised within three and ten years of grant. These conditions are less attractive than EMI and make it more difficult to use them for exit planning.

Given the restrictive conditions and the lack of immediate entitlement to Business Asset Disposal Relief, CSOP is considerably less popular than EMI. However in the right circumstances they can be used to attract key personnel as options can be granted on a selective basis and provide golden handcuffs to existing key personnel.

In conclusion many Entrepreneurs understand the benefit of providing equity incentives to key management. Some individuals do not wish to offer shares to management as it can dilute the family’s interest in a business. Share options can be used which are granted on a selective basis and exit-only. This can be used to bridge the conflicting desires of management incentivisation with perceived loss of family ownership.

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