• Enterprise Management Incentives (EMI)
  
  EMI allows selected employees (often key to the employer) to be given the opportunity to acquire a significant number of shares in their employer company through the issue of options.
  
  
• Share Incentive Plans (SIPs)
  
  A SIP is designed to allow all employees to participate in their business and to encourage long-term shareholding by them.
  

Tax problems under normal rules

If shares are simply given to an employee without using an EMI or SIP, the market value of the shares will be taxed as earnings from the employment. This is expensive for the employee as he/she may not have any cash to pay the tax arising. In order to avoid this immediate charge, options could be granted to an employee. An option gives the employee the right to obtain shares at a later date. Provided that the terms of the option are that it must be exercised within ten years, any tax liabilities will be deferred until the time the options are exercised.

This may still be expensive for the employee if they are not then in a position to sell some of the shares in order to pay the tax arising.

What do EMI and SIPs offer?

EMI allows options to be granted to employees which may allow the shares to be received without any tax bill arising until the shares are sold.

A SIP allows shares to be given to an employee without the market value of the shares being taxed as earnings.

EMI features

How does it work?

Selected employees are granted options over shares of the company. The options should be capable of being exercised within ten years of the date of grant.

In order to qualify for the income tax and national insurance contribution (NIC) reliefs, the options awarded need to be actually exercised within ten years of the date of the grant.

What are the tax benefits to employees?

The grant of the option is tax-free.

There will be no tax or NICs for the employee to pay when the option is exercised so long as the amount payable for the shares under the option is the market value of the shares when the option was granted.

The EMI rules allow for the use of nil cost and discounted options. However, in these circumstances, there is both an income tax and an NIC charge at the time of exercise on the difference between what the employee pays on exercise and the market value of the shares at the date of grant.

The only other possible occasion of charge to tax will be when the shares are sold and a liability to capital gains tax (CGT) may arise. The CGT bill should be low as:

• the shares will constitute business assets for the purposes of taper relief; and
  
  
• when the shares are eventually sold, CGT taper relief will run from the date of grant of the options.
  

For most employees therefore the maximum tax bill will be 10% of the gain made on sale. The example above highlights the tax advantages where an EMI is used compared with ‘unapproved’ options.

What are the benefits to employers?

• Employees have a potential stake in their company and therefore retention and motivation of these employees will be enhanced.
  
  
• Options will not directly cost the employer any money in comparison to paying extra salary.
  
  
• There will often be no NIC charge for the employer when the options are granted or exercised or when the employee sells the shares.
  
  
• The costs of setting up the option plans should be tax deductible.
  

SIP features

How does it work?

All employees must be allowed to participate (except recent joiners who can be excluded).

The plan may contain three elements, each with its own rules.

• Employees can buy up to £1,500 worth of ‘partnership shares’ from their pre-tax and NICs salary each tax year.
  
  
• Employers can give up to two free ‘matching shares’ for each share purchased.
  
  
• Employers can also, or instead, give up to £3,000 worth of ‘free shares’ to each employee each tax year.
  

Employers can therefore implement a SIP providing:

• only partnership shares
  
  
• partnership and matching shares
  
  
• partnership and free shares
  
  
• only free shares
  
  
• all three elements.
  

So, depending on the plan a company sets up, employees can receive up to £7,500 worth of shares for an outlay of £1,500.

There are a number of conditions to ensure that all eligible employees participate on similar terms. But this does not prevent discrimination on the basis of hours worked, remuneration or length of service. Plans can also have performance related features.

Plans must not however favour directors and higher paid employees.

What are the tax benefits to employees?

• Shares kept in a plan for five years will not be subject to income tax or NICs.
  
  
• If shares are taken out after three years, employees will pay income tax and NICs on no more than the initial value of the shares. Any increase in the value of the shares will be free of income tax and NICs.
  
  
• Shares taken out of the plan and sold at once will not be liable to CGT.
  
  
• Dividends paid on shares within the plan are also tax-free if they are reinvested as ‘dividend shares’.
  
  
• Partnership shares may be withdrawn at any time.
  

What are the benefits to employers?

• Employees will have a stake in their company and therefore retention and motivation of staff will be enhanced.
  
  
• If employees buy partnership shares there will be NIC savings on the salary foregone.
  
  
• The market value of the shares used in the plan can be deducted from the profits that will be subject to corporation tax.
  
  
• The costs of setting up and running the plan are also tax deductible.
  

Which is best for the employer?

Although at first sight the SIP may look more attractive than EMI, the EMI route is the first to consider for many employers running small and medium sized companies. This is because:

• EMI can be selective whereas all employees must be allowed to participate in a SIP
  
  
• the setting up and running of a SIP is considerably more complex than an EMI plan.
  

Establishment and running of a trust

Companies will have to set up a trust to hold the SIP shares. This trust has to satisfy certain requirements set out in the legislation.

Extra administration

The amount of work involved in administering a SIP will vary but there will be extra work:

• awards of plan shares will need to be recorded and monitored, so that the correct tax treatment is given when employees take their shares out of the SIP
  
  
• values of the shares will need to be regularly negotiated with the Revenue
  
  
• additional PAYE and NIC obligations may arise.
  

For many employers therefore, EMI is the first type of incentive to consider.

Does the company qualify?

EMI was introduced by the Government to help small higher-risk companies recruit and retain employees with the skills that will help them grow and succeed. The company must therefore:

• exist wholly for the purpose of carrying on one or more ‘qualifying trades’
  
  
• have gross assets of no more than £30 million (£15m prior to January 2002)
  
  
• not be under the control of another company (so if there is a group of companies, the employee must be given an option over shares in the holding company).
  

The main trades excluded from being qualifying trades are asset backed trades such as:

• property development
  
  
• operating or managing hotels
  
  
• farming or market gardening.
  

Which employees are eligible and who should be issued options?

An employee cannot be granted options if they control more than 30% of the ordinary share capital of the company. They must spend at least 25 hours a week working for the company or the group, or if the working hours are shorter, at least 75% of their total working time must be spent as an employee of the company or group.

Subject to the above restrictions, an employer is free to decide which employees should be offered options. The sole test is that options are offered for commercial reasons in order to recruit or retain an employee.

What type of shares will be issued?

EMI provides some flexibility for employers. For example, it is possible to limit voting rights, provide for pre-emption or set other conditions in respect of shares which will be acquired on exercise of an EMI option. The shares must, however, be fully paid ordinary shares so that employees have a right to share in the profits of the company.

When will the rights to exercise options into shares arise?

The options must be capable of being exercised within ten years of the date of grant but there does not have to be a fixed date.

Examples of circumstances in which the options could be exercised include:

• fixed period
  
  
• profitability target or performance conditions are met
  
  
• takeover of company
  
  
• sale of company
  
  
• flotation of company on a stock market.
  

Options can be made to lapse if certain conditions arise, for example the employee leaves the employment.