What are the alternatives to Enterprise Management Incentives (EMI)?
A company is trying to grow and wishes to retain valuable employees although would prefer to tie their performance into the growth of the business. It is important that the employee is incentivised to help grow the company and how better than to dangle the carrot of equity?
By granting an enterprise management incentives options, an employer is giving employees the most tax advantaged form of remuneration they can. However, the EMI legislation sets a number of qualifying criteria that may not be met, including:
The employee may not commit to working enough time
Gross assets may exceed £30m
The number of full-time employees might be greater than 250
Some of the potential alternatives to an EMI include:
Company share option plans (CSOP)
Employee shareholder status
Join share ownership
Deferred or partly-paid shares
Company Share Option Plans (CSOP)
CSOP schemes are approved share option schemes. There is no requirement to include all employees. An employee may only hold options over £30,000 worth of shares at a time.
The employee may suffer an income tax liability at the time of grant if the aggregate of:
The amount payable by the grantee, on exercise, in order to acquire the maximum number of shares that may be acquired under the option
The amount or value of consideration given (if any) for the grant of the option
- Is less than the market value, at the time the option is granted
Favourable income tax treatment is available on exercise: No income tax liability arises in respect of the exercise of an option if it is exercised, provided that the option is exercised no earlier than the third anniversary of the date it was granted.
The disposal of shares should be subject to Capital Gains Tax (CGT). Acquisitions are treated as made at their market actual cost and where, exceptionally, an income tax charge arose on receipt of the option the amount taxed is part of the cost of acquisition for the purposes of calculating a gain. The date of acquisition of the shares is the date the option is exercised.
Following the Finance Act 2013 a company can now offer restricted shares under a CSOP plan. The shares must be part of the ordinary share capital of the company and the majority of the shares of the same class as the option shares must either be held by non-employees or the company must be controlled by employees holding shares of the same class.
The Finance Act 2014 introduced self-certification by the grantor company (rather than seeking approval) that the options that they grant will comply with the legislation.
Employee shareholder status (ESS)
Since 1 September 2013, an entirely new statutory share ownership regime has been possible: employee shareholder status.
The (potential employee) employee and employer must agree and meet these conditions:
They both agree that the individual will be an employee shareholder
The employer (or parent company) must give fully paid up shares worth at least £2,000
The employee must not pay for the shares
The employer must give a written statement of the particulars of the status of employee shareholder
The employee must obtain advice from a relevant independent adviser
The company is required to pay for the employees’ legal advice whether they accept employment or not
The employee cannot accept or agree to an employee shareholder job until 7 days have passed following the day after the receipt of the legal advice
An employee shareholder has a number of rights and both the individual and the employer must understand which rights an employee shareholder will not have. The proposition of ESS is that employees trade a limited number of their statutory employment rights for shares in their employer (ES shares). The rights that may be given up include:
Unfair dismissal rights (apart from the automatically unfair reasons, where dismissal is based on discriminatory grounds and in relation to health and safety)
Statutory redundancy pay
Statutory right to request flexible working except in the 2 week period after a return from parental leave
Certain statutory rights to request time off to train
In addition, an employee shareholder will have to give 16 weeks’ notice to their employer if they intend to return early from maternity, additional paternity or adoption leave.
The rights that could be surrendered include:
To request flexible working
To request training
Not to be unfairly dismissed (other than by reason of discrimination on grounds of race, sex or religion)
The rights involved are unlikely to be considered valuable by many senior employees; even the right not to be unfairly dismissed has a maximum value that is routinely exceeded by executives’ compromise agreements.
The initial award of shares will be taxable although the employee is treated as having given consideration of £2,000. Any part of the value of the share award that exceeds £2,000 will be subject to income tax at the time that the employee receives the award of shares.
In most cases, it is likely that employees will have to pay income tax on the award of their shares and employers may need to operate PAYE and NIC.
On disposal the first £50,000 of shares will be exempt from CGT.
Employees are awarded shares (or other instruments) that have an interest in the company’s future growth potential. The value of the growth interests when acquired by employees is therefore low.
The shares have the scope to grow in value, which will mean that employees should be subject to CGT (assuming anti avoidance legislation does not apply) on any gains.
The creation of a new class of shares may be the easiest method to implement the award. The entitlement is limited to a participation in future value, which is achieved by setting a hurdle to their participation in the capital of the company.
Joint share ownership
An alternative approach is to structure the growth interests as joint ownership interests (known as ‘joint ownership’ or JSOP), which may be appropriate where the company cannot create a new class of shares. An employee acquires shares jointly with another party, typically an employee benefit trust. The joint owners enter an agreement setting out their respective interests in the shares.
An employee’s interest will have a low initial value. Any growth in value should be subject to CGT.
Deferred or partly-paid shares
Another approach is to agree with the employee that they will pay full market value of the shares with the consideration being unpaid. The employee has an obligation to pay at a point in the future.
Any difference between the market value and the value agreed to be paid in the future will be treated as taxable employment income.
Whilst consideration remains outstanding, the employee has an employment-related beneficial loan and will be subject to income tax on the benefit (the liability can be quite low). There are however two main reliefs available against this charge, which will possibly apply.
Where the shares are disposed of and consideration is outstanding it will be a payment of employment income at that time and subject to PAYE and NIC.
Where the shares are sold and the outstanding consideration paid on the same day, HMRC’s practice is to treat the loan as having been paid off before the shares are sold, so no income tax charge should arise and the disposal should be subject to CGT.
Whilst enterprise management incentives are clearly the most tax advantageous, that doesn’t mean it is the best solution or the only solution. On its own, an EMI may not be the right incentive and a combination of incentives could be more appropriate. Careful consideration should be given to all the options available in light of the current shareholders desires as well as the longer term potential for the business.
The relaxation of CSOP rules and introduction of ESS can be very beneficial and the possibility of growth shares should not be overlooked.