Share Options Schemes for High Growth Potential Ventures
In order to persuade quality management into the venture it is often necessary to offer the incentive of sharing in the value they help to create. A share option scheme is potentially a great tool – but it must be set up properly if it is to provide a real incentive rather than just generate a tax bill.
Share incentives for new enterprises
It is often crucial to the success of small and medium sized companies that they attract and retain the best employees, particularly at senior manager and director level. Increasing focus is being given to the way in which share incentives can act as a tax efficient method of incentivising employees both to join and then to stay.
The Enterprise Management Incentive (“EMI”)
The launch of the Enterprise Management Incentive (“EMI”) scheme by the Government in 2000 together with more recent changes to the way in which capital gains arising on a disposal of shares in private companies are taxed have made this a key area for small and medium sized companies.
Details of the EMI scheme are set out below. This scheme has been extremely popular since its launch and Inland Revenue statistics show that over 3,500 companies have so far granted EMI options to their employees.
EMI Scheme Share Options
EMI is a tax favoured share option scheme introduced by the Finance Act 2000. Due to its inter-action with CGT taper relief it is an extremely valuable relief. If properly structured, tax on gains realised can be reduced from a potential income tax rate of 40% to a capital gains tax rate of 10%.
The aim of EMI is to help “small, high-risk” companies attract and retain employees.
The salient points to note as regards EMI are as follows.
• EMI will permit the grant of tax favoured options to eligible employees by “qualifying companies”.
• A company will qualify if it satisfies the following conditions:
it is not under “control” of another company, or another company and persons connected with that company, at the time of grant – note that this test can be breached if the company has, say, one minority corporate shareholder which, with one or more other shareholders, “acts together to secure or exercise” ‘de facto’ control of the company;
it does not have “gross assets” at the time of grant of the options of more than £30 million;
it is a company carrying on or intending to carry on a trade which is not an excluded trading activity or is the holding company of a trading group which satisfies the various conditions; and
the qualifying trade must be carried on wholly or mainly in the UK.
• Excluded trades consist broadly of dealing in land or financial instruments, dealing in goods other than for wholesale or retail distribution, banking and finance, leasing or receiving royalties or licence fees (unless they are attributable to the exploitation of intellectual property created by the company), legal and accountancy services, property development, farming, forestry, hotels, nursing homes or the provision of facilities for other business.
• An employee will be “eligible” to be granted an EMI option provided he, together with his associates, does not control 30% or more of the ordinary share capital of the company and (in the case of close companies) is not entitled to more than 30% of the assets of the company on a winding-up. The employee must also be employed by the company or group for a least 25 hours a week, or, if less, for at least 75% of his working time. Time spent not working due to injury, ill-health, disability, pregnancy, childbirth, maternity / paternity leave, reasonable holiday entitlement and garden leave is included as committed working time for these purposes.
• Each eligible employee may be granted EMI options over up to £100,000 worth of shares (valued as at the date of grant).
• There is no tax charge on the grant, or on the exercise of the option (unless the option exercise price is less than market value as at the date of grant, in which case there is an income tax charge at the time of exercise on the difference between the market value on grant the exercise price).
• For capital gains tax purposes the employee is treated as having acquired the shares at the date of grant of the option so that taper relief, which effectively reduces the gain which is charged to tax according to the length of time the asset has been held, is available from that date. Thus, CGT will be payable on 50% of the gain after one year and 25% after two years effectively bringing the rate for a higher rate tax payer down from 40% to 20% and 10% respectively.
• No national insurance contributions will be payable provided options are capable of being exercised and are in fact exercised within ten years of the date of grant.
• No advance Inland Revenue approval is necessary. It is possible to seek advance assurance from the Inland Revenue that the company is (on the basis of information supplied) a qualifying company. Advance assurance is not available in relation to other matters, such as whether the individual is an eligible employee.
There is, however, a notification procedure and the option will not qualify unless this is complied with. The company must notify the Inland Revenue of the grant of the option within 92 days and supply certain other information. The notification must include a declaration as to its accuracy from the company secretary or one of the company’s directors and a declaration from the employee concerning the working time condition. The Inland Revenue then has 12 months from the end of the 92 day period to make enquiries. Once the enquiry is completed the Inland Revenue must issue a “closure notice”. If this is negative the company or the employee can appeal against the decision within 30 days.
An option can cease to be qualifying if any one of certain disqualifying events occur, such as the company becoming a subsidiary of another company or otherwise coming under the control of another company or the company ceasing to meet the qualifying trade requirement. Where a disqualifying event occurs and the option is not exercised within 40 days of the event an income tax charge arises on exercise based on the increase in value following the disqualifying event. Also, taper relief is restricted.