Employee stock options also known as share options are a form of equity compensation for employees that grant employees the rights to buy shares in their employers' companies. Startups often grant stocks options to reward early stage employees. Businesses can set up Employee Share Schemes to grant share options to their employees. Small companies with gross assets of £30 million or less are able to set up an Enterprise Management Incentive (EMI) scheme which allows businesses to grant these share options tax efficiently. This short article explains what an EMI scheme is and how to set one up for your business.
What are share options?
A share option gives the option holder the right to buy an agreed number of company shares at an agreed exercise price when the share options vest. Share options vesting conditions can be time based or performance based but the tax treatment may vary depending on whether they are part of an HMRC approved company share option plan (CSOP) or not.
What is an enterprise management incentive scheme?
SME businesses with a permanent establishment in the UK, gross assets of £30 million or less, fewer than 250 full-time employees and carrying out a qualifying trade can set up enterprise management incentive (EMI) scheme and grant EMI ordinary share options. Companies that work in ‘excluded activities’ are not allowed to offer EMIs. Excluded activities include:
- property development
- provision of legal services
- ship building
Employers who meet the criteria will need to register their EMI scheme with HMRC before granting EMI options. Employers will also need EMI option rules and an EMI option agreement to grant the options. Due to the tax implications of EMI options, it is usually best practice for small businesses to pay a law firm for legal services with regards to preparing the scheme rules and option agreement.
A small business with an EMI scheme can still grant options to non employees but these share options will be treated as unapproved share options which won't have the same tax benefits as EMI options.
What are the benefits of EMI share option schemes?
A share option scheme is a great way of giving company ownership to employees which can motivate them by allowing them to benefit in the upside of the early stage company's growth. An EMI scheme allows employees to obtain entrepreneurs' relief at the exercise of the options which means they will obtain some tax relief on their capital gains tax (CGT). Employees might need to pay income tax if the shares were granted at a discount of their actual market value. However, when employees are granted the tax-advantaged options, no income tax is owed until the options are exercised.
How to grant EMI share options to employees?
An employer may grant qualifying EMI share options up to a value of £250,000 per employee in a three-year period. The total market value of unexercised qualifying share options a company may grant under EMI cannot exceed £3 million. To grant EMI share options, an employer will first need to obtain the authorisation from the company directors to grant the options at an agreed price. The company will then need to write to HMRC to request the approval of the market value of the shares and exercise price for the specific grant of the options and this is done via a VAL231 form. Finally, you can grant the options to your employees after HMRC approves the exercise price. The employer then needs to submit an EMI notification to HMRC within 92 days of the date of grant which will inform HMRC which full-time employees received stock options and how many.
How do employees exercise the options?
When and how employees can exercise their EMI options will depend on the employer's specific EMI rules and the vesting conditions of their options. Once options have vested, employees can usually exercise their options if and when the employer company is bought by an acquirer or if they leave the company.
How to manage Enterprise Management incentives schemes?
To create and manage your EMI schemes, you will need to access your HMRC account with your 12 character Government Gateway ID and password.
Once you're logged into your HMRC account, you'll view a page which lists the services for your company such as PAYE and Employment related securities (ERS). You can create and manage EMI share option plans by clicking on the ERS section.
Simply click on the link and you'll access your PAYE page which will give you the option to view your EMI schemes, file returns and notifications, register a scheme or arrangements or make Enterprise management incentives (EMI) notifications.
How to submit an EMI annual return?
The company secretary or the person acting as the company secretary must complete an online annual return on or before 6 July for each registered EMI scheme. The annual return must indicate whether EMI options have been exercised, adjusted, replaced, released, lapsed or cancelled (for example if an employee leaves before the options vest). If nothing has changed then you must still submit nil returns.
Clicking on view returns will provide a list of the EMI share option plans you have registered with HMRC. Click on the scheme for which you'd like submit an annual return. You will then be able to select the type of notification you'd like to submit.
You will then be able to see annual returns for previous tax years and the option to create new ones.
Submitting a return simply requires clicking on the link. You can submit a nil return if nothing has changed during the tax year. If not, you must make an online filing of HMRC's EMI end of year return template which is available to download as an ods file. The file provides a procedure for adjustments, replacements, released, lapsed or cancelled options, non-taxable and taxable exercising of options. The document requires employee information such as their national insurance number as well as information about the options such as the actual market value of the shares, their exercise price and the date of grant of the the options. HMRC provide further information on how to complete the ods document in guidance notes and technical notes. You can contact the HMRC technical support team if ever you encounter technical difficulties during the online filing.
Why should you grant EMI options to your employees?
As an employer, granting EMI options to your employees is a great way to give them ownership in your company so that they can participate financially in the company's success. You can incentivise potential candidates with stock options in an employment offer letter and your employment contracts can contain provisions around the grant of share options.
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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.