For companies looking to implement an employee share incentive scheme, EMI options have always had tax benefits over unapproved options. These have been made even better with recent legislative changes which now mean that Entrepreneurs Relief (“ER”) will apply to all disposals of EMI shares acquired by way of options exercised on or after 6 April 2013, provided the option/shares have been held for 12 months.
EMI options can give employees a high value incentive on which they pay tax at a 10% rate (if ER applies), while the company is able to claim corporation tax relief at 20% or more. This gives EMI options a significant advantage over issuing ordinary shares to employees, particularly if the individual is to hold less than the normal 5% shareholding required in order to qualify for ER.
ER provides for a 10% rate of CGT on business assets if certain qualifying conditions are met for the 12 months preceding the date of disposal. In order to qualify for ER in respect of shares, the individual must have held at least 5% of the ordinary share capital and these shares must entitle them to 5% of the voting power in the company (the “personal company” requirement).
Previously, EMI share option holders did not normally benefit from ER as options were typically exercised immediately before a sale (therefore failing the 12 month holding period), or they involved shareholdings of less than 5%. EMI shareholders were therefore usually subject to CGT at 28%. The relaxation of the ER rules for EMI shares now makes the scheme much more attractive.
The following example illustrates the very beneficial tax position for the employee and the issuing employer company.
An employee is granted options over shares with a market value of £100,000. The options are exercised shortly before the company is sold 18 months later. The employee receives £250,000 for their shares, resulting in a gain of £150,000. The tax position is as follows:
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