How not to lose your EMI tax relief if you reorganise or restructure

What are the key issues and pitfalls encountered where a company is reorganising and it has subsisting enterprise management incentive (EMI) options?

In summary the way the legislation works is that the EMI tax relief can be lost unwittingly as the legislation is complex.   

If you are worried about the implications on your exiting EMI Scheme of significant changes in your business, please do call or email us. We are specialists in Enterprise Management Incentives and the associated legal and tax aspects.

Why reorganise your business?

The reasons for a company reorganising its share capital are varied.  Typical reasons include setting up a new holding company, restructuring different business lines or getting ready for an exit.

Steps to consider

  1. What does the option agreement or plan rules say?

First, the terms of the option agreement or plan rules need looking at to determine what will be the effect of the reorganisation on subsisting options – for example, will options be exercisable on the re-organisation or can they rolled over (replaced) or will they lapse?    

  1. Timetable

It is prudent to factor into the re-organisation timetable the steps relating to options, including option holders communications, and if powers of attorneys should be sought to expedite the process.   

  1. Re-organisation and re-structure

For tax purposes, if as part of a re-organisation or re-structure a new holding company is placed on top of an existing company, it will be a change of control and a disqualifying event under the EMI legislation (because the existing company will cease to be ‘independent’).  Further, if EMI options are exercised on or following a re-organisation, option holders will only benefit from income tax relief (in full) if they exercise their options within 90 days of a disqualifying event (this assumes their option exercise price was not set at a ‘discount’ to the grant date market value because any discount will always be within charge to income tax on exercise.)

In many instances there are good reasons why the parties would not want a re-organisation to ‘trigger’ inadvertently the exercise of options over the existing company’s shares. The main reason is a re-organisation is not an exit event and there is no money available to option holders for exercise.

Potential solutions for avoiding early EMI option exercise

  • Compulsory roll over – The option agreement or plan may anticipate such a re-organisation and include terms on which option holders will be subject to a ‘compulsory’ roll over (this would be to prevent the exercise of options ‘early’).  If the existing documentation does not include the power of compulsory roll over these types of clauses cannot be inserted once options have been granted without loss of EMI tax status. But, lack of a clause is not necessarily detrimental.
  • Roll over offer – The acquiring company may offer the company’s option holders the opportunity to roll over their options for new options over the acquiring company’s shares capital. The alternatives are to grant qualified EMI replacement options or non-tax advantaged replacement options.
  • Qualified EMI replacement options – Qualified EMI replacement options would obviously be preferred by option holders who would expect to preserve the ability to obtain income tax relief on future exercise of their replacement options.  In practical terms whether the tax status can be preserved will largely depend upon whether the acquiring company will meet the EMI qualifying conditions for the grant of replacement options. This will turn on complying with a number of conditions (summarised in outlined below): including how the re-organisation is structured; the share capital of the acquiring company and the terms and conditions of the roll over options granted to option holders.

Conditions for qualified EMI replacement options 

These include :

  • the consideration given for the old shares in the existing (‘old’) company consists entirely of newly issued shares in the acquiring company;
  • when the new shares are issued to shareholders in exchange – only the new shares and the subscriber(s)’ shares are in issue in the acquiring company;
  • the new shares issued to shareholders in exchange must ‘mirror’ the classes of shares and share rights as existed in the old company. (For example, where A, B, C and D share classes existed in the old company then equivalent share classes with broadly identical shares rights must be created in the acquiring company) (See further below regarding ‘Qualifying EMI – equivalence and replacement options’);
  • new shares will need to mirror the old shares (as above) and be issued to shareholders in proportion to their old shareholdings, and
  • the exchange of shares is not treated as involving a disposal of the old shares.

Other conditions to work around to achieve EMI status on the replacement options

There are also other conditions which the roll over options must comply with to preserve EMI tax status. These include:

  • the total exercise price of the roll over options must be identical to the old options;
  • the total market value of shares subject to the roll over option must be the same immediately after its grant as the total market value of shares subject to the old option immediately before its exchange;
  • the £3 million overall EMI company/group limit (as to the market value of shares subject to options) must be satisfied in respect of the roll over options, except this limit is based on the market value of shares under options in the old company when the old options were granted;
  • the acquiring company must satisfy the independence and trading activities requirements at the date of grant of the roll over options (this means a subsidiary company cannot be used as the acquisition vehicle);
  • roll over options must be granted by reason of employment with the acquiring company (or group company), and the option holder must be an eligible employee at the time of the grant; and
  • the grant of the roll over options must be notified to HMRC within 92 days of grant.

Non-tax advantaged replacement options

Non-tax advantaged replacement options will be taxed as unapproved options from the date they ceased to qualify as EMI.  This means that some of the profit made by the option holders on exit will be taxed to income tax and national insurance – this was not the intended outcome for the former EMI option holders.  There are other alternatives to explore.

There are HMRC reporting requirements which we can take you through.  Usually employers are not responsible if options do not qualify for EMI but there will be an unhappy work force to manage!

Preserving the tax status of EMI options under a re-organisation is not a straightforward area by any means.  In our experience advanced planning may alleviate problems if it allows you to plan the re-organisation in a way that avoids problems for EMI option holders.

Please do speak to us with any questions.

Catherine Ramsay

Manages to explain difficult concepts in easy to understand language. In tune with her clients.

Let us take it from here

Call us on 020 7438 1060 or complete the form and one of our team will be in touch.