Enterprise Management Incentives (EMI) - …

1 Enterprise Management Incentives (EMI) The continued growth and success of your business is dependent on your workforce. It is, therefore, important to ensure that you are recruiting, incentivising and retaining the right people. A share based incentive scheme can help you to achieve these goals. Share schemes can be split into two categories: HM Revenue & Customs (HMRC) approved schemes that offer tax benefits but sometimes with little flexibility; and unapproved schemes that offer increased flexibility but at the cost of tax disadvantages. This briefing focuses on the most common form of approved share incentive schemes, Enterprise Management Incentives or EMIs. What is an EMI? EMIs are tax advantaged share options. Under the plan, employees are given (granted) the option to acquire shares in their employer company within a specified time period and at a fixed price.

2 The option to acquire shares can be conditional, perhaps based on the employee meeting certain performance targets, but must be exercisable within ten years of the grant. Typically, there will be no income tax or national insurance contributions (NIC) to pay once the employee exercises the option and purchases the shares, although this does depend on a number of factors including the option price. There can also be favorable tax treatment on the eventual sale of the shares by the employee. How will an EMI benefit my company? Remuneration of staff Shares can be awarded to your employees in return for their services, perhaps in place of a cash bonus; Performance incentive Giving your employees the opportunity to participate in the growth in value of your company can help to incentivise and motivate your workforce; Retention of staff Perhaps the most important reason to implement an EMI is to help retain those key members of staff that will help to make your company grow.

3 Can any company run the scheme? There are certain qualifying conditions that must be met in order for a company to implement an EMI. The company must carry on a qualifying trade. All trades will qualify unless they are specifically excluded from participation, specifically: Dealing in land, commodities or futures, shares, securities or other financial instruments; Dealing in goods, otherwise than in the course of an ordinary trade of wholesale or retail distribution; Banking, insurance, money-lending, debt-factoring, hire purchase financing or other financial activities; Leasing (including letting ships on charter, or other assets on hire) or receiving royalties or other licence fees; Providing legal or accountancy services; Property development; Farming or market gardening; Holding, managing or occupying woodlands, any other forestry activities or timber production Shipbuilding, producing coal and producing steel.

4 Operating or managing hotels or comparable establishments, such as a guest house or hostel, or managing property used as a hotel or comparable establishment; Operating or managing nursing homes or residential care homes, or managing property used as a nursing home or residential care home. The total gross assets of the company, or a group, must not exceed 30 million at the date of grant. Gross assets means all the assets which would be shown on the balance sheet, without any deduction in respect of liabilities. Ordinarily, an EMI company will be unquoted. However, providing they are small enough, a quoted company may also qualify. The company and its group must have fewer than 250 full time equivalent employees at the date of grant. The company must not be a 51% subsidiary of a parent company and arrangements must not exist which could result in the company becoming a 51% subsidiary or otherwise being controlled.

5 Furthermore, the company must only have qualifying subsidiaries. For a company to be a qualifying subsidiary, the parent company must own at least 51% of the voting power in the subsidiary. The company must have a permanent establishment in the UK. Alternatively, in the case of a parent company, at least one company in the group that is carrying on a qualifying trade must have a permanent establishment in the UK. Can all employees participate? Due to the popularity of EMIs, the government abolished the limit on the EMI Views expressed in this article are those of the contributor. No responsibility for loss occasioned by any person acting or refraining from action as a result of the material in this newsletter can be accepted by the LLP or any of its associated concerns.

6 Kingston Smith LLP is registered to carry out audit work and regulated for a range of investment business activities by the Institute of Chartered Accountants in England & Wales. A member of KS International. number of employees that can participate in the scheme. However, it should be noted that the maximum value of options that a company can grant is 3 million. Furthermore, the maximum value of shares (valued at the date of grant) over which an employee holds options can not exceed 250,000. The employee must be employed by the company, or one of its qualifying subsidiaries, whose shares are the subject of the option and work at least 25 hours per week. However, part time employees can qualify providing they do not spend more than a quarter of their time working for anybody else.

7 The individual must remain a full-time employee or director of the company, or its group, at all times during the duration of the option. Employees with a material interest in the company cannot participate in the scheme. A material interest means controlling more than 30% of the share capital of the company. What are the tax benefits of an EMI? The main benefit of an EMI is the beneficial tax and NIC treatment which applies to the shares purchased. When compared with the tax and NIC implications of unapproved schemes, it is little wonder that EMI is proving to be so popular. Employee Tax treatment of unapproved options There will be no income tax or NIC implications on the grant of an option. When the employee exercises the option there will be income tax (and possibly NIC) charged on the difference between the market value of the option shares at the date of exercise and the total price paid for those shares (if lower).

8 There is also capital gains tax (CGT) to consider should the employee decide to sell the shares acquired. CGT will be charged on the amount by which the sale proceeds exceed the market value of the shares at the date of exercise (subject to availability of the annual CGT allowance or specific CGT reliefs). Tax treatment of EMI options As with unapproved options, there is never a tax charge on the grant of an EMI option. Providing there is no discount on the shares at the date the employer grants the options, there will be no tax or NIC to pay when the options are exercised. Broadly speaking, this means that the price the employee will pay to purchase the shares cannot be less than the actual market value of those shares on the day the option is granted. If, however, a discount is offered to the employee at the date the option is granted, there will be an income tax (and possibly NIC) charge at the date the option is exercised.

9 However, the way in which we calculate the income tax charge on the exercise of EMI options is slightly different to the calculation when the exercise is under an unapproved share option. The tax is actually charged on the lower of the market value of the option shares at the date of grant or the date of exercise, less the total price actually paid for the shares. There will also be a capital gains tax charge when the employee eventually sells the shares. The capital gain is simply calculated as the difference between the sale proceeds and the cost. The cost is the amount actually paid for the shares, plus any amount charged to income tax on exercise (only applicable if the options were issued at a discount). However, it doesn t end there, as the Government has enhanced the tax advantages of the EMI scheme by allowing gains made on shares acquired through exercising EMI qualifying options on or after 6 April 2012 to be eligible for Entrepreneurs Relief (ER).

10 Therefore, providing that the employee has held the shares for a period of 12 months or more, any capital gain realised on the sale will be taxable at 10% rather than 28%. There must, therefore, be at least a 12 month period of ownership of the shares before the shares are sold. Unlike shares acquired under other circumstances, holdings of less than 5% can qualify for ER. Company A UK company will qualify for corporation tax relief on the practical costs of setting up an EMI scheme. In addition, a UK company should qualify for a corporation tax deduction for the excess of the market value of the shares at exercise over the amount paid for them by the employee. Where options are granted at or above market value, there will be no NIC costs for the UK company on grant or exercise of the option.