EMI Option Schemes and Company Share Option Plans are two types of share incentive plans which can offer generous tax benefits for eligible employees. As of April 2023, the Government has streamlined the legal and administrative process for companies seeking to adopt these schemes, which it is hoped will spur an increased take-up and bring greater benefits to employers and employees alike.
When seeking to incentivise employees by offering them a stake in a company, EMI options are a very tax-efficient tool. Employees can be granted options over shares in their employer company whose exercise price can often be set reasonably low. If structured and administered correctly, the gain in the value of the shares which the employee acquires on exercise can be chargeable to the lower rates of capital gains tax (CGT) as opposed to income tax, including the beneficial 10% rate of Business Asset Disposal Relief (BADR). By offering a greater upside in value on an employee’s stake in a company, their interests can be more closely aligned with those of the company itself and the scheme can be structured flexibly to deliver value on a liquidity event such as a sale or listing and also be based on satisfaction of time or performance conditions.
Similarly, for companies who may not be eligible for EMI options, for example, because they are too big or whose trade or activity is excluded, Company Share Option Plans (CSOPs) are another potential route for incentivising employees in a tax-advantaged manner. The individual and company limits on the value of shares available under CSOP are a lot lower than EMI options and generally they must be held for three years in order to be exercisable free of income tax. However, recent relaxations of the rules relating to both of these types of share option plans (effective from 6 April 2023) may make them even more attractive going forward.
While the essence of EMI options remains the same post 6 April 2023, a few key administrative features have been amended or removed.
Restrictions for EMI purposes are the restrictions on shares over which an EMI option is granted. They are most commonly found in a company’s articles or in a separate shareholder agreement (such as leaver provisions for employee shareholders or pre-emption rights on transfer) and their presence is important for determining the market value of a share for EMI purposes (it is generally required to agree a valuation with HMRC before EMI options are granted).
The legislation previously spelled out that restrictions on a share must be set out in the option agreement. While omitting to do this would on the face of things mean an option was not a valid EMI option and has often been the source of concern in due diligence, HMRC’s guidance had suggested they would overlook the omission in certain circumstances.
As of 6 April 2023 and helpfully for all existing EMI options exercisable at that date, the requirement to include restrictions in an option agreement has been removed. This will lessen the disclosure burden on sellers of companies which have granted EMI options and ensure that no employees might be disproportionately disadvantaged by a seemingly innocuous oversight in the option documentation.
Working time declaration:
Employees seeking to secure the full tax benefits of EMI options must generally work full-time (either at least 25 hours per week or 75% of their working time for the employer or fellow group company of the employer which grants the options). The legislation also specified that the employee must certify this fact at the time of grant (and it was often included as a sentence in a written option agreement).
From 6 April 2023, the requirement to make this working time declaration has been removed and as with the change regarding restrictions, it also applies to exercisable options in existence at this date (though the requirement to actually work full time remains).
While seemingly small, there have been a number of instances of the declaration not being present in an option agreement or otherwise verifiable, leading to diligence concerns and so this relaxation should give sellers and buyers one less thing to worry about on an M&A transaction involving a target which has granted EMI options.
The grant of a new EMI option must be notified to HMRC within 92 days if it is to qualify as an EMI option (though HMRC has been known to be lenient on this and they do allow a late notification where there is a ‘reasonable excuse’). For existing EMI options, there is a different deadline of 6 July following a tax year of a certain occurrence relating to the option, such as it vesting, it being cancelled or lapsing, or if nothing happens (a nil return is still required).
From 6 April 2024 (not 2023), notification of a new EMI option may be made to HMRC by 6 July following the tax year in which the option is granted, which is generally a much more generous timeframe than 92 days.
The changes should make the process of granting and notifying EMI options easier and lead to fewer irritating questions in due diligence.
Increase in value of shares under option:
Companies operating a CSOP were only permitted to grant options over shares worth a maximum of £30,000 to an eligible employee. From 6 April 2023, this limit has doubled to £60,000. While the amounts are not massive, this will be a welcome boost to companies seeking to hire or retain key staff with an offer of tax-efficient equity on a more scaled up basis.
Removal of restrictions on share classes for CSOP shares:
For companies with more than one class of ordinary share, it was previously the case that the majority of the shares of the class used for a CSOP must be either ‘employee-controlled’ (held by employees or directors who control the company) or ‘open market shares’ (acquired by persons otherwise than as a result of employment/directorship (unless as part of a public offering), or by trustees acting on behalf of such employees or directors). Therefore it has generally not been possible to have a CSOP over a class of shares for employees only. The desire was that the CSOP shares would be ‘worth having’ – that they would not just end up as a lower class of shares specifically for employees.
This ‘worth having’ requirement has also been removed as of 6 April 2023 for CSOP companies which have more than one class of ordinary share (and applies in respect of CSOP options granted on or after 6 April 2023, and generally in respect of shares acquired by the exercise of options on or after that date regardless of when those options were granted). This is a welcome simplification for companies which have more than one class of ordinary share (particularly those which are venture-capital backed or otherwise have multiple share classes). It is also hoped that these CSOP amendments will make CSOPs cheaper and more attractive incentive routes where the more generous EMI option route is unavailable (for example for companies whose gross assets exceed £30m or who operate in excluded fields such as financial services or property development).
If you are seeking advice on the issues raised in this article or on share/share option incentives generally then please contact Anthony Reeves or Cathy Bryant.