In the current economic climate, it is increasingly common for owner-managed businesses to incentivise key employees by offering equity. This approach can play a vital role in recruitment, retention and succession planning, while also ensuring that employees’ interests are aligned with those of the shareholders.
When structured correctly, equity-based incentives can be highly effective in supporting growth plans and exit strategies. However, awarding shares to employees involves navigating through various legal and tax complexities. If these are not carefully managed, significant tax liabilities can arise where an employee receives an asset (such as shares) for less than its full market value. This is often referred to as a ‘benefit in kind’.
There are several types of share schemes available that enable businesses to recruit, retain and incentivise employees in a tax-efficient way. It is important that business owners seek specialist legal and tax advice to ensure the most appropriate scheme is selected and implemented correctly, allowing the intended benefits to be unlocked by all parties.
One of the most common arrangements is an Enterprise Management Incentive (EMI) scheme, largely due to its flexibility and benefits. Key features of EMI schemes include:
- Discretionary participation – the scheme does not need to be offered to all employees, allowing businesses to target key individuals (unlike some schemes, which require wider participation).
- Options rather than immediate share ownership – employees are granted options to acquire shares at a future date, typically on a defined event such as a sale of the business or once certain time-based or performance conditions are met. If an employee leaves before the options are exercised, they will usually lapse automatically, ensuring the departing employee does not retain an interest in the business.
- Flexibility and ease of administration – EMI schemes are generally more straightforward to operate than other share incentive arrangements.
- Performance and exit conditions – employers can impose conditions that must be satisfied before options can be exercised, such as achieving key performance indicators, financial targets, or the occurrence of a sale.
- Protection against ‘benefits in kind’ – the exercise price is agreed with HMRC at the date of grant. This helps avoid income tax liabilities arising on exercise, even if the market value of the shares has increased between the grant and the acquisition of the shares.
- Corporation tax relief – on exercise of the options, the company may be entitled to a corporation tax deduction, enhancing overall shareholder value.
- Favourable capital gains tax treatment – employees may be able to benefit from a reduced rate of capital gains tax by claiming Business Asset Disposal Relief on a future sale.
To be eligible for the tax advantages associated with EMI schemes, strict statutory requirements must be met by both the employer and employee, and the supporting documentation must be carefully prepared. Obtaining specialist legal and tax advice at an early stage is essential to avoid future complications, including unexpected tax liabilities.
For further information on EMI schemes, or for advice on other corporate matters, please contact Matthew Ray at Matt.Ray@swinburnemaddison.co.uk or call 0191 384 2441.
