Since 2001's Finance Act, share options for employees have been dominated by one initiative - the enterprise management incentive or EMI scheme.

Dubbed by some as one of the chancellor's best contributions to the world of small and medium-sized enterprises, the EMI has proved a very attractive way for smaller businesses to offer long-term incentives to key employees as well as becoming a highly useful tax planning tool.

Mainly aimed at smaller entrepreneurial businesses, the EMI stacks up a number of tax benefits for both employers and employees. They are normally free from income tax. They are free of national insurance for both employer and employee and they receive favourable capital gains tax treatment.

In fact, since the 2003 Finance Act, the scheme has become even more attractive to companies, as the schemes are now deductible for corporation tax for the difference between the market value of shares and the exercise price.

For accountants specialising in employee incentive schemes, EMI has proved a relatively easy sell. They are more flexible than traditional share incentive plans and company share option plans. And although they do have some limitations, for unlisted companies in particular they offer companies that are heavily reliant on human capital some protection against losing staff to competitors.

According to the Inland Revenue, there are currently 4,957 companies on the EMI database and 48,933 options granted under the scheme.

Nick Wallis, head of the share schemes unit at Smith & Williamson, says the EMI is pretty hard to beat. Apart from a few restricted trades - accountancy firms don't qualify, for example - it is, he says, the answer to a prayer for most clients. 'You can sit down with the client and for virtually any incentive scheme requirement the answer will be EMI,' he says.

Hanging on to the stars

Graham Morgan, corporation tax partner at Kingston Smith, says that more often than not it's a question of 'if you don't have an EMI, why not?' In his own client base, for example, media companies, marketing services businesses and advertising agencies can prove vulnerable if star performers leave to set up in business for themselves.

An EMI with length of service conditions built in will encourage staff to stay, particularly in a sector where senior staff are very attracted to owning shares in the business they work in. 'Everybody in marketing wants to be a shareholder, even to the extent of paying for over-priced shares,' he says.

He says there can be problems around valuation issues. Owner managers may have inflated ideas about the value of their companies given their emotional attachment to their businesses. Granting a share in the business to others and diluting their own stake can be similarly problematic, he says.

Nick Hood, partner at Begbies Traynor, says that providing management teams are open to the idea of providing an incentive scheme, the idea of EMI is not hard to get across. Proprietors will have to reconcile themselves to regular valuations of their companies and that will have a cost implication, but overall the schemes are inexpensive and can be set up for as little as 4,500 to 6,000.

Advisers agree that from a staff incentive point of view, the EMI is most effective for companies that have a flotation or trade sale in their plans. Hood says the issue with trade sales is - as ever - finding a buyer.

Some companies set up a trust to buy the options in the event of someone wanting to sell. Others will try and set up a mini-market for share options, especially if the business is mature enough to have perhaps six or seven shareholders. 'They will find it easier to motivate staff if there is an end-point,' he says.

With a company that plans to float, the advantages of EMI are particularly strong. Staff have all the more reason to work to achieve a higher share price at issue.

Defying the sceptics

Nick Wallis says that although the introduction of EMI was greeted with a degree of scepticism it has not proved difficult to administer from a regulatory point of view. Initially, the scheme looked similar to early profit-related pay set-ups, in that there seemed to be scope for the Revenue to crawl over each and every arrangement.

In practice, the Revenue has shown a commendable light touch in its regulation of EMI, he says. Providing advisers keep within the guidelines, the Revenue remains non-interventionist.

Wallis says the trick with EMI is to take the administrative load off the client. 'There are plenty of pitfalls if you forget to notify the Revenue, or forget to register the scheme. We take care of all those elements for clients. We diarise each scheme, make sure returns go in and so on.

But in essence there are only two things to get right: communicating the scheme and getting on top of the administration.'

Tax treats

The EMI's very favourable tax treatment means real gains for both employer and employee. It is free of national insurance for both employer and employee, the exercise of the share option is normally free of income tax and when sold, any gain will incur business asset taper relief from the date the option was granted rather than when it was exercised. For Wallis it is the corporation tax deduction at exercise that is the real advantage for companies in pure tax terms.

Given the advantages of EMI, could the scheme benefit from any improvements?

Wallis says he would recommend taking away undue restrictions on the trades that can set up EMIs as he believes them to be unnecessary. He would also like to see an approval process rather than registration of shares and believes that the restriction of these benefits to employees who work full time is also unnecessary. But apart from these simplifications, he sees the EMI as fundamentally sound. Its advantages far outweigh the disadvantages, especially for smaller companies.

The only issue that leaves commentators slightly confused is the question of why the chancellor has been so generous. Graham Morgan says EMI has been introduced as part of the government's drive to encourage a share-owning economy, but that it may be the case that Gordon Brown did not foresee the popularity of the scheme. 'EMI was introduced at a time of low activity in terms of trade sales and flotations. You could say he's been a victim of his own success.'

EMI - THE ESSENTIALS

•   To qualify, companies must be engaged in a qualifying trade, be mainly UK-based with gross assets of under 30m.

•   Options on shares up to a value of 100,000 can be granted to any number of employees up to a maximum of 3m. Employees must be full time.

•   The scheme is intended to help high risk, entrepreneurial businesses.

Restricted trades include legal and accountancy firms, financing and leasing companies, property development and others.

•   A full list of restricted trades together with a guide to the scheme is at www.inlandrevenue.gov.uk/pdfs/ir2006.htm.