What Is an EMI Scheme and How Does It Work?

An Enterprise Management Incentive (EMI) scheme is a share option plan in the United Kingdom, designed to help growing companies attract and retain skilled employees. This government-backed initiative provides significant tax advantages to both the company and its employees. It is a valuable tool for businesses that may not have extensive cash reserves for competitive salaries, aligning employee interests with company growth by offering a stake in future success.

Fundamentals of EMI Schemes

An EMI scheme is a share option plan granting eligible employees the right to purchase company shares at a predetermined price, often the market value at the time of the grant. This mechanism attracts smaller, growth-oriented companies by offering a substantial incentive without immediate cash outlay. Companies use EMI schemes to motivate employees, fostering a sense of ownership that aligns individual efforts with business success.

For employees, the primary advantage is the potential for significant capital gains and favorable tax treatment. They benefit from the company’s increase in value, realizing a profit when they sell their shares. This creates an incentive for long-term commitment and performance, giving employees a direct financial interest in the company’s growth.

To qualify for an EMI scheme, a company must meet specific HMRC criteria, including:

• Gross assets not exceeding £30 million when options are granted.
• Fewer than 250 full-time equivalent employees.
• Being independent, not controlled by another company.
• Operating a qualifying trade, with certain activities like banking, property development, or financial services generally excluded.
• Maintaining a permanent establishment within the UK.

Individual employees must also satisfy certain conditions. They must be employees or directors working for the company for at least 25 hours per week, or at least 75% of their total working time. An employee cannot hold a “material interest” of more than 30% of the company’s share capital, either directly or indirectly, before the options are granted.

The EMI Share Option Journey

The EMI share option journey begins with the grant of options, the formal offering of the right to buy company shares. This involves drawing up an option agreement specifying the number of shares, exercise price, and conversion conditions. The exercise price is often set at the market value of the shares at the time of the grant, which is important for favorable tax treatment.

Following the grant, options undergo a vesting period. Vesting schedules determine when an employee gains the right to exercise options, often based on a set employment period (e.g., three to five years) or performance targets. This design encourages employee retention and aligns individual performance with company milestones, ensuring employees earn their stake over time.

Once options have vested, the employee can exercise them. Exercising an option means paying the agreed-upon exercise price to convert options into company shares. This conversion can occur after vesting, upon a company sale, or when an employee leaves under specific “good leaver” clauses. The shares then become fully owned by the employee, providing shareholder rights.

The final stage is the sale of these shares, typically after a company acquisition or an initial public offering. This transaction realizes the financial gain from share appreciation. Proceeds from this sale are then subject to capital gains tax, which, under EMI rules, often benefits from advantageous rates.

Taxation Under EMI

EMI options offer significant tax advantages at various stages. When granted, there is generally no Income Tax or National Insurance Contributions (NICs) payable. This upfront tax relief distinguishes EMI schemes from other employee share schemes.

Tax implications arise when options are exercised. If the exercise price was set at or above the market value of the shares at the time of grant, no Income Tax or NICs are due on the difference between the market value at exercise and the exercise price. However, if the exercise price was set below the market value at grant, the discount may be subject to Income Tax and potentially NICs at exercise.

When EMI shares are sold, Capital Gains Tax (CGT) applies to the increase in value, calculated from the exercise price (or market value at grant, if higher) to the sale price. Employees may be eligible for Business Asset Disposal Relief (BADR), formerly Entrepreneurs’ Relief. If applicable, BADR can reduce the CGT rate to 10% on qualifying gains up to a lifetime limit of £1 million, provided shares have been held for at least 24 months from the grant date. This rate is lower than standard CGT rates (e.g., 20% for higher rate taxpayers). The BADR rate is scheduled to increase to 14% from April 6, 2025, and to 18% from April 6, 2026.

Companies also benefit from EMI scheme tax relief. The company granting options can claim a Corporation Tax deduction. This deduction equals the difference between the market value of shares at exercise and the exercise price paid by the employee. This tax relief helps offset scheme implementation and management costs.

Implementing and Managing an EMI Scheme

Implementing an EMI scheme involves several preparatory steps for compliance and benefit maximization. An initial step is obtaining an independent valuation of the company’s shares. This valuation, determining “Actual Market Value” and “Unrestricted Market Value,” must be agreed upon with HMRC. Companies can apply for advance assurance from HMRC regarding this valuation, which helps set the exercise price and provides tax treatment certainty.

Once valuation is established, formal EMI scheme rules and individual option agreements must be drafted. These documents outline option terms, including vesting conditions, exercise procedures, and clauses for scenarios like an employee leaving or a company sale. Board and shareholder approval are necessary to adopt the scheme and authorize option grants.

Following the grant of EMI options, companies must adhere to mandatory HMRC notification requirements. For options granted on or after April 6, 2024, HMRC must be notified by July 6 following the end of the tax year of the grant. Failure to meet this deadline can result in the loss of tax benefits. This notification is submitted through HMRC’s online Employment Related Securities (ERS) portal.

Ongoing EMI scheme management includes annual reporting to HMRC. Companies must submit an annual return, Form EMI40, via the ERS online service by July 6th after the tax year end. This report details all EMI scheme activities, such as grants, exercises, lapses, or cancellations of options during the tax year. Maintaining accurate and detailed records of all EMI scheme documentation, including option agreements, board minutes, and vesting schedules, is also important for compliance and future reference.