We all know that as a business grows, you can’t do it on your own, and increasingly if you want to attract and retain A-players, offering them equity in some form is the best or indeed often the only way to do this.
Losing a key employee to the competition is painful, costly and in a worst case scenario could be fatal to your business. However, faced with this imperative, business owners then find there is a dazzling array of schemes out there to choose from. Which is the best?
Is EMI the most tax efficient route?Most experts agree that EMI (Enterprise Management Incentives) is the most tax efficient scheme currently available.
- It allows employees to benefit from Business Asset Disposal Relief (BADR, formerly Entrepreneurs’ Relief) even if their shareholding is less than 5%, meaning they pay just 10% tax on up to £1 million of gains on ultimate sale.
- Grant of EMI options to employees is cashless and tax free, and exercising the options is also tax free if they were granted at market value.
- And a further bonus is that the company gets a corporation tax deduction on the difference between issue price and the market value at the date of exercise of the option. This can be very significant and essentially results in a negative overall tax cost.
So does this mean EMI is always the best choice?For these reasons, EMI is often the first scheme that advisers will start talking about. But it isn’t always the right fit, and we often see advisers trying to fit a square peg into a round hole; simply because it’s the most tax efficient route doesn’t necessarily mean it’s the best one for you.
Here are some reasons why EMI might not be the best fit:
- You want employees to benefit from dividends on their shares
- You are on the list of excluded trades (this includes some unusual activities, but also some quite conventional businesses such as hire companies)
- Some of the individuals you want to be on the scheme are not technically employees or don’t work full time for the business
- You want employees to have the option of cashing in some of their shares prior to a business sale*
- You have a holding company that you don’t want employees to be involved in, or your business is majority owned by a third party investor
What other options are there?In our experience the most popular and flexible alternative route is a growth share scheme.
This is not a government-sponsored ‘tax advantaged’ scheme but is tax efficient and, importantly, very flexible. It can be used in any type of company for any individual (no requirement to be an employee or work full time).
It can be structured so as to avoid interfering with group parents or personal investment companies, and also to allow employees to cash in some of their shares early if everyone is in agreement.
The shares are low cost at the point of issue, and on ultimate sale the employee will typically pay 20% capital gains tax on the increase in value of the shares, which is still a very reasonable rate.
Are there any downsides?One of the benefits of EMI is that it is possible to get HMRC approval on the valuation of the shares; this is not available with growth shares, leaving a level of uncertainty; added to which growth shares can be difficult to value in a way that does not leave you open to HMRC scrutiny and challenge in the future.
However, a robust, documented and market data-backed valuation process will go a long way to mitigating this risk.
A further downside can be a psychological one – once an employee has shares they might take the view that they don’t have to try any more, whereas share options (such as EMI) give the feeling of having to work to achieve something, and can be made conditional on future performance.
Can you make growth shares conditional, then?Yes, in a word. Building conditions into employees acquiring their shares is a great way of creating both short term growth and a long term incentive and ‘tie in’. These can be company-wide or personal, or a combination of both – but it’s best not to make them too complicated.
If this sounds like something your company could benefit from, feel free to reach out and we will be glad to explore the options with you. We will never assume a solution before we have explored your situation, the drivers and your future plans, allowing us to propose the best solution for your business. This might be EMI – but equally it might not.
* Some advisers will talk about using an Employee Benefit Trust (EBT) to facilitate this; whilst possible, this comes with a lot of complexities, costs and practical challenges and for this reason the EBT route is much less popular than it once was.
For more information on how we can help you and your business, please contact us via firstname.lastname@example.org or call 02476673160 for support and advice. Let’s work together to grow and strengthen your business.
Please note: This article is provided for information only and was correct as at time of writing (25/11/23). Any lists and details provided above are not exhaustive and are not intended to be full and complete guidance. No action should be taken without consulting detailed legislation or seeking independent professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this article can be accepted.