The Enterprise Management Initiative

The incentivisation of employees by allotment of shares in the capital of their employer is an extremely effective way of tying in key personnel. Although there have been for some time a number of tax incentives available to encourage employee share ownership the basic proposition is that shares allotted will prima facie be liable to income tax and national insurance on the market value of the shares on the date of allotment. In addition the Company has to pay secondary class national insurance contributions on the value.

Following the Finance Act 2000 it is now possible to provide incentives to recruit and retain key employees in a tax efficient manner in the form of share options granted under the Enterprise Management Incentive ("EMI") Scheme. From an employee's point of view under an EMI Scheme there are the following advantages:-

1. Income Tax:-

Provided that qualifying conditions are met there will be no income tax liability at the date the options are granted. On the exercise of the option no income tax liability will arise provided that the price paid to exercise the option is equal to market value of the shares at the date the option was granted. If the price paid is less than market value income tax and primary and secondary class 1 national insurance contributions will be payable on the difference. In circumstances where an employee does not have to pay for the shares then income tax under the EMI scheme will not be payable until the date the option is exercised which could be immediately before the date on which the shares are sold. This contrasts favourably to a straightforward allotment of shares where income tax would be payable on the allotment itself even although the shares would not be sold until a later date. Accordingly one of the key benefits of the EMI scheme is that it postpones any income tax charge on the allotment of shares until a later date which could be the date when the shares are sold hence realising the cash to pay the tax liability.

2. Capital Gains Tax:-

On the ultimate disposal of shares any increase of value will be liable to capital gains tax. However taper relief will be available to offset against the gains based on the length of time between the grant of the option and sale of the shares. Accordingly shares will qualify for taper relief at the business asset rate if the shares are sold more than four years after the date of the grant and the tax payable on any gain arising will be at 10%. Contrasting this with the straight forward share allotment taper relief will start to accrue from the date the shares are acquired. Accordingly the grant of an option to acquire shares over a period of time will have the advantage of enabling taper relief to start to accrue on all of the shares from the date of the grant.

The tax treatment of EMI is extremely favourable and a number of qualifying conditions have to be met. The key conditions are as follows :-

1. the company granting the options must be independent and not under the control of another company;

2. the company must be carrying on a qualifying trade in the United Kingdom. Examples of non-qualifying trades include property development, banking investment activities etc.. Alternatively the company must be a holding company of a trading group in which the holding company has at least 75% of the voting power in each subsidiary;

3. the gross assets of the company/group must not exceed £15,000,000 at the time the options are granted;

4. no more than 15 employees can hold qualifying options;

5. the employee must be employed for at least 25 hours per week or if less 75% of the working time;

6. the employee must not own more than 30% of the shares in the company after the option is to be granted;

7. the shares must be ordinary shares;

8. the maximum value of unexercised options that can be offered to an employee cannot exceed £100,000. The value is determined at the date of grant and must be agreed with the Share Valuation Division of the Inland Revenue;

9. the options must be exercised within ten years of their grant.

The concept of the EMI scheme is fairly simple although its implementation will be complex. It would be advisable for a form of Share Option Agreement to be drawn up identifying specific performance requirements and to ensure that the terms of this Agreement are not in conflict with the company's Articles of Association and any Shareholders Agreement. The Share Option Agreement must then be submitted to the Inland Revenue for approval and the value of the shares agreed with the Shares Valuation Division.

Anybody wishing to find out more about EMI should contact Morinne Macdonald or David Beveridge.