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Business Tax  •  Personal tax  •  Share Schemes  •  Tax Planning

Pros and cons of the Employee Share Scheme (ESS) vs. the Enterprise Management Incentive (EMI) share option scheme

By Lesley Stalker on 15 June, 2015

 

An employee share scheme can be a powerful staff motivator; it can also be highly tax efficient and such schemes have consistently been shown to increase employee productivity and business performance. Sharing the rewards of success with employees can be a cost effective way to remunerate staff and build long-term loyalty. In short, an employee share scheme can encourage employees to think like business owners and become more accountable and productive.

It has long been accepted that for SMEs wishing to incentivise staff, the Enterprise Management Incentive (EMI) share option scheme is the most cost effective and tax efficient way to proceed. There is however a newcomer on the block in the form of the Employee Shareholder Scheme (ESS) which enables employees to own shares immediately and to benefit from generous tax exemption.

It is worth considering the differences between the schemes and how they can be used.

What is the ESS?

ESS is share scheme which enables company employers to offer a different form of employment status to employees together with the ownership of shares.

Employees agree to waive or vary certain employment rights such as the right to claim unfair dismissal except on the ground of discrimination and in relation to health and safety; the right to statutory redundancy pay; to accept reduced rights to request flexible working and time off for training. In exchange for accepting these reduced rights they can be issued with at least £2,000 worth of shares in their employing company or its parent.

From a tax perspective, ESS is very attractive because shares having a value of £2,000 or less at the time of award are exempt from income tax, and gains arising on a sale of the shares are exempt from capital gains tax (CGT) to the extent that they had a value of £50,000 or less at the time of award.

 

Overview

  • Shares worth a minimum of £2,000 must be issued;
  • There is no upper limit over the number of shares that can be issued, or the value of those shares;
  • The individual must not pay for the shares in any way;
  • Shares issued with a value of up to £50,000 at the time of issue will be exempt from capital gains tax when sold;
  • No restrictions apply to the type or size of company that can offer ESS shares;
  • The issue of ESS shares can be coupled with other incentives, such as growth shares;

 

What is the Enterprise Management Incentive (EMI) share option scheme?

Firstly it is important to note this is a share option scheme rather than an outright award of shares, as with ESS. However options can be exercised quickly if the scheme rules allow it.

The employee is granted options to acquire shares in the future at their current market value. The option can be exercised at a time agreed in advance. This could be within a matter of weeks or months; on certain targets being met; or immediately before a trade sale, as required.

No tax is payable on grant of the option, or on exercise providing the agreed market value is paid. On a disposal, CGT is payable on the difference between the sale proceeds and the exercise price, often at 10% because entrepreneurs’ relief (ER) is usually available.

 

Overview

  • Highly tax efficient but only available for companies with assets of up to £30million;
  • No income tax or NICs are payable on grant of the options or on exercise, providing the agreed market value is paid on exercise;
  • Entrepreneurs’ relief (ER) accrues from the date of grant of the options and no minimum shareholding is required for this purpose;
  • Subsidiary companies and companies involved in banking, farming, property development, legal services and ship building do not qualify.

 

Summary of the different tax rules and implications

EMI ESS
Company concerns
Can be used by subsidiary company? No – top company only yes
Any restrictions on type of trade? Yes No
Any restrictions on size of company? Yes No
Corporation tax relief? On exercise based on market value less exercise price On market value of shares at date of award
Employee concerns
Maximum value of shares at grant/ award £250,000 No maximum value
Income tax position No income tax on grant or exercise provided market value is paid Income tax payable to the extent that the value on award exceeds £2,000
CGT position Payable on difference between sale price and exercise price No CGT if value of shares on award is £50,000 or less
ER qualifying differences ER applies from grant of options ER applies from award of shares
No minimum shareholding required Minimum 5% shareholding
Maximum shareholding 30% 25%
Agreement of market value in advance with HMRC? Yes Yes

In summary, whilst the EMI remains as popular and useful as it ever was, there are certain circumstances where the ESS may prove preferable such as for subsidiary companies, those whose trade will not qualify for EMI, companies whose shares currently have a low value, or who want to issue growth shares with additional tax advantages.

If you are interested in offering a tax efficient, HMRC approved share scheme for employees, please contact Lesley Stalker by emailing las@rjp.co.uk.

 

 

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