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Employee share options: EMI and CSOP arrangements

/ 26 November 2023

Stephen Deutsch

The enterprise management incentive (EMI) and company share option plan (CSOP) are both ‘discretionary’ share option schemes. EMIs and CSOPs allow a company to offer an interest in their equity to individual participants as the company sees fit.

Both option schemes aim to help small high-risk companies to attract and retain key people and to reward employees for taking that risk.  They allow employees to benefit from capital treatment on the growth in value of their option shares between the date of the grants of the option and the date of their exercise.

The company may also benefit from these schemes as they may provide an employer National Insurance contribution (NIC) saving and corporation tax relief.

EMI scheme

Which companies qualify for EMIs?

Although most small and medium-sized trading companies would qualify, certain companies whose principal activity is that of leasing, property development and financial activities will be excluded from the EMI scheme.

The company need not be resident in or incorporated in the UK, but it must:

  • be an independent company which is not under the control of any other company; and
  • have a Permanent Establishment in the UK; and
  • have gross assets not exceeding £30 million.

A group of companies will be able to offer EMI option shares to employees who are employed in either the parent company or a subsidiary, but:

  • the business of the group as whole may not, to a substantial extent, carry on non-qualifying activities and must have a permanent establishment in the UK;
  • the group must have at least one company that wholly carries out a qualifying trade;
  • the group assets must fall within the £30 million gross asset limit. In this instance, the EMI option shares must be those of the parent company.

The company may be quoted or unquoted.

How do employees qualify for share options?

Qualifying companies will be able to offer EMI share options to any employee who controls 30% or less of the ordinary share capital of the company. In arriving at the percentage, shares that are still under option are disregarded.

An employee will be eligible for EMI options if they are employed for:

  • at least 25 hours a week; or
  • 75% of their working time if less than 25 hours.

However, the company cannot have more than the equivalent of 250 full-time employees at the time of the grant of the option.

What would be the value of the share options?

Up to £250,000 worth of options may be awarded to an employee.

At any one time, employees may hold EMI options with a value of up to £250,000 at the date of grant. Any restrictions and conditions attaching to the shares may not be taken into account in valuing those shares to determine whether the limit has been breached.

How are the shares classed?

EMI shares must be fully paid-up ordinary shares so that the employee has the right to share in the profits of the company.

This excludes the use of redeemable and convertible shares as EMI option shares, but the rules do permit considerable flexibility to certain other rights attaching to the shares. For example, it will be possible to limit voting rights or provide for pre-emption rights.

How do the tax breaks work?

No tax or NICs are payable at the date of the grant of an option or its exercise.

To qualify for income tax and NIC relief under the EMI scheme, companies must ensure that the options they award are capable of being exercised within ten years of the date of grant.

Employers must also ensure that the exercise price is set at the market value of the shares at the time the options are granted.

Although the EMI rules permit the option price to be below market value of the date of the grant, in these circumstances there is an income tax charge (and NIC charge where the shares are quoted or readily convertible into cash) at the date of exercise. The charge is on the difference between the market value at the date of the grant (not exercise, as with a normal unapproved share option) and the amount the employee pays.

What happens when the shares are sold?

Capital gains tax (CGT) is payable on the gain when the shares are sold.

CGT Business Asset Disposal Relief (BADR; formerly Entrepreneurs’ Relief) may be available on gains arising on option share disposals. Where an employee is eligible, tax will be payable at a rate of 10%.

The conditions for this enhanced relief are met by an individual who:

  • has been an employee or officer of the company for at least 24 months to the date of sale; and
  • has at least 5% of the company’s shares which have been owned for 24 months up to that disposal date.

CGT BADR is available on holdings of less than 5% for EMI option shares.  This relief is available in those circumstances so long as the individual:

  • has been an employee or officer for the 24 months to the date of sale; and
  • their EMI option over the shares was granted at least 24 months prior to the share disposal date.

CSOP

Companies that fail to satisfy the EMI conditions – perhaps because the company carries on a trade that is excluded for EMI purposes, has gross assets that exceed the £30 million maximum or has more than 250 employees – may wish to consider granting CSOP options.

At any one time, employees may hold CSOP options with a value of up to £60,000 at the date of grant, so this individual limit attached to CSOPs remains significantly lower than the EMI limit of £250,000.

The exercise price under the option will be the market value of the option shares at the time the option is granted.

In terms of timing, the exercise of the option must take place within a period beginning three years from the date on which the option is granted and ending on the tenth anniversary of the date of grant, although there are some exceptions. The three-year rule does not apply to employees leaving for redundancy, injury, disability or retirement, where there is a cash takeover or where the employing company is sold out of the group within the three years following grant.

Tax implications

Income tax

There is normally no tax charge at

  • the date of the grant
  • the date of exercise of the option

Capital gains tax

CGT is payable when the shares are sold.  The gain will be arrived at by deducting the amount paid for the shares from the disposal proceeds received on sale.

The employee may therefore benefit from the CGT annual exemption, a 20% tax rate except where the BADR conditions are satisfied when a 10% tax rate will apply.  The CSOP arrangement provides an advantage over an unapproved scheme under which an income tax charge (and possibly an NIC liability) arises when the option is exercised.

The scheme must provide that:

  1. Each participant must be either a full-time director or an employee. Whereas a director must work for the company for at least 25 hours per week, there is no working time restriction for an employee.
  2. The option grantee may not, in the preceding 12 months to the option grant, hold more than 30% of the ordinary shares of the company, or such rights that would on a winding-up give an entitlement to more than 30% of the assets.
  3. The option exercise price will be the market value of the shares at the date the option is granted.
  4. The scheme shares form part of the company’s ordinary share capital and could be over a class of shares exclusively for employees.

For more information about EMI and CSOP arrangements, and how your business might take advantage of them, please get in touch with your usual BKL contact or use our enquiry form.

Stephen Deutsch

Senior Adviser, Tax

T +44 (0)20 8922 9119
E stephen.deutsch@bkl.co.uk

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