Frequently Asked Business Question:
I am currently employed and my employer has offered me the opportunity to participate in an Enterprise Management Incentive Scheme, can you explain what my tax position would be if I participated?
Generally, when an employee receives shares in connection with their employment, they are classed as Employment Related Securities. Therefore, if an employee benefits from shares due to their employment, for example, receives free shares or shares at a discounted price, income tax and national insurance contributions could become due (potentially at an effective tax rate of 47%).
However, to assist businesses to retain and motivate key members of staff and encourage share ownership the Government introduced the Employee Management Incentive (“EMI”) scheme over 20 years ago.
The Employee Management Incentive Scheme is a UK share option scheme designed for Small Medium Enterprises to incentive and reward key employees. The scheme allows the employer to reward the employee with share options, which can be exercised at a later date to obtain shares at an agreed price. The EMI scheme is subject to certain qualifying conditions and there are a number of tax advantages for both the employee and the employer.
When share options are granted to the employee, there are no income tax charges or national insurance contributions due. However, it is also important to note that employment-related securities have two different values, i.e. the actual market value (“AMV”) and the unrestricted market value (“UMV”). The AMV is the value of the shares with restrictions attached and the UMV is the value of shares without any restrictions attached. The UMV would always be higher than the AMV. Therefore, it is important to clarify the AMV and the UMV of the shares when options are granted as it could impact your tax position at a later date.
On exercise of the options by the employee, usually, no income tax or national insurance contribution charges would arise, if, at a minimum, the shares were acquired at their AMV at the grant of the options. In the event that the price paid is lower than the AMV (when the options were granted), income tax and national insurance contributions would be due on the difference between the price paid and the AMV.
Also, on the exercise of the options, consideration also needs to give, by the employee, if a claim is to be made under an S431 election. The S431 election ensures that on the future disposal of the shares (providing the UMV was paid for the shares or income tax paid on a discount from UMV) no additional income tax charge would arise and full gain would be chargeable to capital gains tax. The S431 election is a legal document and needs to be submitted within 14 days of the transaction. This could be the most tax-efficient way of acquiring the shares, however, the acquisition cost of the shares would also be higher.
In the event that the UMV is not paid for shares and/or no S431 election is in place, any gain on the future disposal of the shares would be subject to both income tax and capital gains tax. In this scenario, the acquisition cost of the shares would be lower but you could incur a higher tax charge at a later date.
As noted, the future disposal of the EMI shares would fall within the scope of capital gains tax, payable at a rate of 20% (assuming you are a higher rate taxpayer). However, EMI shares qualify for Business Asset Disposal Relief. This relief results in an effective capital gains tax rate of 10% rather than the normal capital gains tax rate of 20%. It should also be noted that a capital gains tax rate of 10% is considerably lower than an effective income tax rate of 47% that could arise on employment-related securities.
For the employer, generally, there would be no national insurance contributions on the exercise of an option and once the options are exercised the company would receive a corporate tax deduction. This would be equal to the difference between the market value of the shares to a 3rd party and the actual price paid by the employee. at the date of exercise.
For more information and/or assistance, please contact our Tax Team who will be pleased to help you.