Why should I implement an EMI scheme over a cash bonus?
An EMI scheme grants a conditional option to an employee to receive the right to a number of shares. Is that better than a cash bonus?
13 December 2022
Technology, Media and Telecommunications
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An Enterprise Management Incentive (“EMI”) scheme is a tax-advantaged HMRC approved share option scheme. It works by granting an option to an employee to receive the right to a number of shares if particular exercise conditions are met at a future date. How does that compare to a cash bonus?
EMI scheme
Under an EMI scheme, income tax is only due if the shares under option are acquired at a discount, for example by the employee paying less than the HMRC agreed market value.
National Insurance Contributions are only due if income tax is payable and the shares are readily convertible into cash, either through a stock exchange or an agreed sale.
Any increase in share value above the HMRC agreed market value will be subject to Capital Gains Tax on sale of the shares.
HMRC also exempts some of the Business Asset Disposal Relief (“BADR”) conditions, formerly Entrepreneurs’ Relief, for shares acquired through an EMI. The exemptions remove the requirement for the employee to hold a minimum 5%, and the 24-month holding period starts from the date the options are granted.
It is therefore possible for any capital gains as a result of an EMI, up to a lifetime limit of £1m, to be taxed only at 10%.
For the employer, HMRC permits a corporation tax deduction for the difference between what is paid by the employee and the market value at the time the employee exercises their options to become a shareholder.
Cash bonus
Cash bonuses on the other hand do not provide any tax exemptions or efficiencies.
Whatever cash bonus is received gross by the employee would be subject to income tax, at potentially 45%, and National Insurance Contributions.
The employer would also suffer 13.8% employers National Insurance Contributions.
Comparisons
EMI and cash bonus schemes can be operated in similar ways. For example, both can be applied only to selected employees and can be dependent upon meeting certain performance targets, although such targets are optional.
Having a target linked to maximising future sale value through a cash bonus or shares (and cash on the subsequent sale of those shares) can be a great way to incentivise, reward and retain key employees with a vested interest in the success of the company.
However, any cash bonus linked to the sale of a business could be deemed a cost of the transaction, and therefore treated as capital in nature that is not deductible for corporation tax purposes.
When designing any remuneration or incentive scheme, communication with employees is always important for engagement and to ensure the benefits are not under-appreciated.
It should also be said that some employees are more motivated by cash now than a future share sale, even if it is more tax efficient, and the advantages between an EMI scheme and a cash bonus are dependent on each individual’s circumstances.
Overall, provided the qualifying conditions are met, EMI is a more tax efficient way to get cash into the hands of employees, on the subsequent sale of the shares. It is also particularly useful if the company does not have sufficient cash reserves to pay significant cash bonuses to staff and is looking for longer-term incentivisation.
The qualifying conditions of an EMI scheme are extensive, and designing an effective scheme is essential to obtaining the maximum benefits.
Further information
If you would like any assistance with discussing the design or implementation of an EMI, other share scheme or cash bonus scheme please do not hesitate to contact a member of our tax team.
EMI share options
See also our other articles on EMI share option schemes:
