Date posted: 27th Sep 2021
As the country lurches from one shortage to another, many of our clients are worried about the shortage of skilled employees and the potential risk that employees will leave for a competitor on better terms and conditions.
One method of staff retention (if you are a limited company) may be to make use of the tax advantages of an Enterprise Management Incentive (EMI) scheme, particularly if you are anticipating a share sale, at some point in the next 5-10 years.
A limited company employer is able to offer employees options to acquire shares in the company, which can be used as a long term incentive. In basic terms, a share option agreement provides the employee with the legal right to buy shares in the future, at a price fixed today. Under the EMI scheme, that price will be agreed with HMRC up-front, to avoid any complications.
The tax advantages are:
- There is no income tax charge on the grant of options to acquire shares.
- Assuming that the employee acquires shares at the market value, at the time of being granted the options, they do not pay income tax on this value.
- When the shares are sold, any gain should be subject to capital gains tax (assuming it is set up correctly) which could be as low as 10%.
There are many pitfalls to consider when setting up an EMI scheme, so professional advice should be taken.
We feel that an example can best demonstrate how the EMI scheme works – of course, the example assumes that all of the qualifying criteria for the employee and company are met.
Joe Bloggs Limited has been growing rapidly and there has been some interest from venture capitalists as well as national and international organisations. The managing director and founder, Joseph Bloggs, anticipates that there may be a sale of the entire share capital within the next five years, due to the rapid growth of turnover and profits.
However, key to the operation of the business, is the head of business development, Sarah Smith.
Joseph realises that he cannot afford to lose Sarah at a critical time for planning for the sale. He therefore speaks to our tax advisory team, who recommend that he considers offering Sarah a shareholding in the business. However, simply issuing shares to Sarah either directly from a new issue or from his own shareholding, will mean significant tax charges will arise.
Our tax team have therefore recommended that he sets up a company EMI scheme to reward Sarah. A valuation of the shares is agreed with HMRC at £500 per share and Sarah is granted options over ten shares which will eventually give her a 5% shareholding in the business.
Eventually an acceptable offer is made for the entire share capital of the company of £10m, after another four years. Sarah therefore exercises her option to acquire her ten shares for £500 per share (total cost £5,000) and shortly thereafter, the entire share capital of the company is sold for £10m.
Sarah receives £500,000 for her 5% shareholding. To calculate her tax liability, she can deduct the £5,000 she paid for the shares and has a capital gain of £495,000. If she has her c£12,000 capital gains exemption available, she can also deduct this, to leave her with a taxable gain of £483,000, on which she could pay tax as low as £48,300.
After buying the shares and paying tax, Sarah therefore has £446,700. Sarah has therefore benefitted significantly from staying with the company and Joseph has benefitted as Sarah has been instrumental in driving new business which led to the sale at an acceptable value.
If you have any queries in relation to staff remuneration packages or EMI schemes, please give us a call or contact us here.