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Share Options
EMI (Enterprise Management Incentive) Scheme
C-SOP (Company Share Option Scheme)

Generally

This FAQ may be of particular interest to the company in a situation of growth, perhaps working towards a flotation which may result in substantial capital gains on the value of its shares.

Often in such a situation the company wishes to cement relations with its key employees, to reduce the risks of being tempted away by competitors in exchange for higher salaries, and to offer an additional reward, contingent on them remaining with the company through the rapid-growth period. Awarding share options - the right to acquire shares at some future date at a price that is fixed now - can be a very useful way to help achieve that objective.

The big attraction is that, apart from the relatively low costs of setting up the scheme, it costs the company virtually nothing. The reward received by the employee is the right to acquire shares tomorrow, at a price fixed by reference to today's value.

If the company is floated, then the employee whose options have 'vested' (ie who now has the right to exercise the option and actually buy the shares) will often buy and sell them simultaneously - so (s)he will never actually have to put up any money before (s)he can realise the gain.

The employee has the hope of a substantial gain in the value of the shares, before the employee actually has to make a commitment to buy them - and the knowledge that his/her commitment and contribution to the company will influence the extent of that gain in value.

If the shares do gain value and the employee exercises the option and makes money, who will end up having paid? Those to whom the shares are eventually sold. And, to a minor extent, the value of the holdings of other shareholders will have been diluted. But compared to paying more money now, this is likely to be a far more acceptable price to pay.

Setting up a scheme

It's easy to set up a share option scheme. The challenge is to ensure that it is tax-efficient. There are three points at which such a scheme might have undesirable tax consequences:

• Grant of the option - when the individual is formally given options under he scheme.
• Exercise of the option - when the individual exercises his rights under the scheme to actually buy shares.
• Disposal of the shares - when the individual ultimately realises the investment.

From a tax point of view, there may be a potential liability at each of these stages:

• Grant of the option - the individual may be receiving as a non-cash emolument of his employment the right to acquire shares at less than their true value. If so, that may be a benefit which is taxable at the date of grant of the option, based on the difference between the option price and the market value of the shares at the date of grant of the option - even if the option cannot yet be exercised.
• Exercise of the option - at this point the benefit received may be the difference between the price payable under the option, and the then market value of the shares. There may be a further tax liability here if the value of the shares has increased since the value at the date the option was granted.
• Disposal: there may be a capital gains tax liability, or (under some circumstances) an Schedule E growth charge - ie, an income tax liability.

Legislation provides different schemes which offer tax advantages for share options. Each such scheme has its own conditions. Each must not only comply with the conditions appropriate to the type of scheme, but also be approved by the Inland Revenue as so complying.

EMI

The conditions which an Enterprise Management Incentive (EMI) Scheme must fulfil are laid down in Finance Act 2000 s62 and Schedule 14 (as amended by Finance Act 2001 s62 and Schedule 14). The key conditions are as follows:

• The company must be an independent trading company (additional conditions apply if the company either is, or has, subsidiaries)
• Each individual to whom an option is granted must be a key individual in the business, and must not already have more than a 30% shareholding
• The company’s business must not fall within certain excluded fields (extended by s33 Finance Act 2008)
• Options over shares can be granted to an unlimited number of employees, provided that the total value of options granted does not exceed £3,000,000 at the time of grant;  unexercised C-SOP options are taken into account in calculating the £3,000,000
• the maximum value of shares over which any one employee may be granted options is £120,000
• The gross assets of the company (generally, total balance sheet assets, ignoring liabilities) at the date of the grant of the option do not exceed £30,000,000
• There must be a document granting each option, and this must contain certain specified information
• The grant of each option under the scheme must be separately notified to the Revenue within 92 days of the grant
• The terms of the option may be different for each individual
• The Company, the employee, and the business of the company must all satisfy certain other requirements
• The option must be granted for commercial reasons in order to recruit or retain a key employee
• The company must have no more than 250 full time employees (s33 Finance Act 2008)

After an option has been granted under an EMI scheme, there are a few points to be borne in mind if the option is to remain within the scheme:

• any proposed changes to the Company’s share capital must be for commercial reasons;  increasing the market value of option shares must not be a main purpose of any such changes
• Changes to share ownership which result in the company becoming a subsidiary of another, or in the company acquiring a subsidiary, may have effects on the options continuing to qualify under the scheme, and should be considered carefully

The benefits are:

• No income tax or National Insurance charge on grant of option
• No income tax or National Insurance charge on exercise of the option, if the option price was no less than the market value at the time the option was granted
• A gain realised on sale of the shares may be subject to capital gains tax, but taper relief will apply from the date of grant of the option.

Overall, the EMI scheme is more flexible and easier to set up and administer than a C-SOP. 

Setting up such a scheme simply involves us collecting certain information to check that your plans qualify for the scheme, and drafting an option agreement (which can be quite simple). 

The scheme does not (unlike the C-SOP) need to be submitted for Revenue approval, although there is now a procedure in place whereby the Revenue are willing to express an opinion on whether the company will meet the qualifying requirements.

It is necessary however for you to agree a per share valuation basis with the Revenue;  this is in order to prove that the option price was no less than the market value at the time the option was granted.  We would not ourselves normally become involved with this process, and would generally expect it to be dealt with by you and your accountants.  There are a number of valuation methods available, and their appropriateness would depend on the type of business being assessed, and the size of the shareholding. Most consultancies for example would probably start from the "multiple of turnover" approach and adjust that as appropriate, taking into account eg:

• The fact that a minority holdings in a private company may generally be regarded as having a value less than a pro rata proportion of the total value of the company, to take account of fact that (from the optionholder’s viewpoint), the vulnerability of the company being under the control of a third party
• Dividend track record (if any) of equivalent shares in the company to date
• future cashflows, particularly where there are any firm prospects of changes to the company’s fortunes.

More details on this topic can be found in the Revenue share valuation division manual (see in particular chapters 5, starting at 5020).

 C-SOP

The conditions which a Company Share Option Plan (C-SOP) must fulfil are laid down in Income and Corporation Taxes Act 1988 Sch 9, FA 1991 s38, FA 1995 s137, and FA 1996 ss 114 & 115 & Sch 16. The key conditions are as follows:

• The value of shares for which a person may hold options is limited to £30,000.
• The share price must be specified when the option is granted.
• The share price must not be manifestly less than the market value at the time the option is granted.
• The option must not be exercised less than 3 years or more than 10 years after it was granted.
• The options must not be exercised more frequently than once every three years.
• The employer may choose which members of staff are invited to join the scheme.

The benefits are:

• No income tax charge on grant of option - no great concession, since the price payable on exercise must be no less than the value at the date of grant of the option.
• No income tax charge on exercise of the option. This is where the benefit lies.
• A gain realised on sale of the shares will be subject to capital gains tax - but not a Schedule E growth charge.

Setting up such a scheme involves drafting the document which lays down the rules of the scheme. Then you simply need to have your accountants get formal approval for the scheme from the Inland Revenue, and grant the options to your chosen employees.

We can set up such a scheme for you. If you feel a C-SOP might be of interest to you, mail me.

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This page was last updated 16th May 2008

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