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Tax Bite - Alternatives to EMI Options

EMI options are the most attractive form of employee share incentives available, however they won’t always be available, for example where:

• The company is too big, in terms of numbers of employees or gross assets;
• The company carries on EMI-excluded activity or has investment activities;
• The individual is not a full-time employee;
• The individual already has £250,000 worth of EMI options, or (together with anyone connected to him) has 30% or more of the shares; or
• There’s an exit event for the company in prospect.

What else might a company consider if EMI options are not available?

Unapproved options

These are simple and mean no up-front investment or risk, but they are not tax efficient at all, and the tax charge on exercise can be particularly punitive if there is an earn out, which at worst could result in the optionholder paying income tax on some value he never actually achieved.

CSOP options

These are worth considering particularly where the company is too big for EMI or carried on an EMI excluded activity. From 6 April 2023, there have been some very useful relaxations in the CSOP rules, in terms of the types of shares that can be subject to CSOP options (e.g. including growth shares) and a doubling of the initial market value limit from £30,000 to £60,000.

CSOP options remain the “poor relation” to EMI for discretionary tax-advantaged share options, but they can deliver the same fundamental key tax benefit as EMI (no income tax on exercise) in the right circumstances.

Acquiring shares up front (including growth shares)

This does not benefit from any tax exemption or relief as such, but the idea is that once an employee owns shares, any growth in value should be subject to capital gains tax rather than income tax.

Income tax (and possibly NICs) will be payable on acquisition if the employee pays less than market value. If ordinary shares in the company are valuable, companies will often look to put in place growth shares i.e., a class that only participates in value above a hurdle. Unlike with EMI and CSOP options, the initial market value of shares under these arrangements cannot be agreed with HMRC, and we know that HMRC are taking an increasingly strong stance in arguing that growth shares have at least value on acquisition. This is even if (say) the hurdle is set at what the parties consider to be a margin over the current value of the company, as HMRC consider there should be some expected growth in value and therefore potential future return on the shares, albeit discounted for uncertainty and time.

Growth shares are of course commercially different to ordinary shares. However, you can look at putting in place “catch up” mechanisms in a tax efficient way to try and get growth shareholders into the same economic position as ordinary shareholders on an exit. For example, the employee could have a second class of growth shares with a higher hurdle, which take the majority of the value in a particular “slice”, which works so long as the value on exit is at least equal to the top of that slice.

Nil paid shares

If paying for (or being taxed on the value of) shares up front is not palatable, shares can be issued nil paid subject to an obligation to pay up the initial market value later. Normally this can (so long as carefully implemented) be structured to ensure there is ultimately no income tax (save for tax on the benefit of the deemed loan that arises on acquisition) for the employee. However, if the value of the shares goes down or the company becomes insolvent, there is a problem as the employee would be taxed on any amount of the deemed loan that is waived. For this reason, nil paid shares are rarely used for employees where the company does not want to burden them with this debt, but they can be useful for sophisticated recipients e.g. non-execs who may be prepared to take that risk for the better tax outcome.

Cash bonuses

Whilst fully income taxable of course, bonuses have their place due to simplicity.

Where bonuses are being considered in the context of an impending share sale, it may be worth considering whether an unapproved option might be used instead. There’s no income tax or NIC benefit to the employee, but depending on the circumstances there may be a better chance of the company obtaining a corporation tax deduction for the value of the shares under the option, compared to cash transaction bonuses where HMRC generally do not accept that the bonus is CT-deductible.