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

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

In summary, EMI tax relief can be lost unintentionally because the relevant legislation is complex and requires careful consideration.

If you are concerned about the implications of significant changes in your business on your existing EMI Scheme, please do call or email us. We are experienced in EMI Schemes 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 establishing a new holding company, restructuring different business lines or preparing for an exit.

Steps to consider

They key considerations for any EMI Scheme include the following:

What do the option agreement or plan rules say? - First, the terms of the option agreement or plan rules need to be reviewed to determine the effect of the reorganisation on subsisting options. For example, will options be exercisable on the reorganisation or can they be rolled over (replaced). or will they lapse?    

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

Disqualifying event under the EMI Rules?

For tax purposes, a company reorganisation can result in a disqualifying event, including where an existing EMI company loses its independence. However, certain reorganisations can qualify for replacement EMI options, provided the statutory conditions are satisfied. If an EMI option is exercised more than 90 days after a disqualifying event, the tax advantages will generally not be preserved. This assumes the option was not granted at a discount to the market value at the date of grant, as any discount can give rise to an income tax charge on exercise.

In many instances, there are good reasons why the parties would not want a reorganisation to trigger the early exercise of options over the existing company’s shares. The main reason is that a reorganisation is not necessarily an exit event and option holders may not have the funds or an opportunity to realise value from exercising their options at that stage.

Potential solutions for avoiding early EMI option exercise

• Compulsory roll over - The option agreement or plan may anticipate such a reorganisation and include terms under which option holders are subject to a ‘compulsory’ roll over, preventing the options from being exercised early. If the existing documentation does not include the power of compulsory roll over, these types of clauses cannot generally be added after options have been granted without risking their EMI status. However, the lack of such a clause is not necessarily detrimental.
• Roll over offer - The acquiring company may offer option holders the opportunity to roll over their options for new options over the acquiring company’s share capital. The alternatives are qualifying EMI replacement options or non-tax-advantaged replacement options.
• Qualified EMI replacement options - These would generally be preferred by option holders who would expect to preserve the ability to obtain income tax relief on future exercise. Whether EMI status can be preserved will depend on the structure of the reorganisation and whether the statutory conditions for replacement options are satisfied.

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, the new shares and subscriber shares are the only shares in issue in the acquiring company;
• the new shares issued to shareholders in exchange must correspond to the classes and rights of the shares in the old company;
• new shares will need to mirror the old shares 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 for capital gains tax purposes.

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

There are also other conditions that 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 applicable EMI company/group limit must be satisfied in respect of the replacement options, with the relevant value determined by reference to the old options;
• the acquiring company must satisfy the independence and trading activities requirements at the date of grant of the roll over options;
• 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 replacement options must be notified to HMRC through the Employment Related Securities (ERS) online service by 6 July following the end of the tax year in which they are granted.

Non-tax advantaged replacement options

Non-tax-advantaged replacement options will be taxed as unapproved options from the point at which they cease to qualify for EMI. This means that the growth in value attributable to the period after the disqualifying event may be subject to income tax and, where applicable, National Insurance contributions. This may not be the intended outcome for former EMI option holders. Other alternatives may be available depending on the circumstances.

There are also HMRC reporting requirements which need to be considered as part of the reorganisation. Usually, employers are not responsible if options do not qualify for EMI, but the loss of EMI tax advantages can have significant consequences for employees and may create wider employee relations issues.

Preserving the tax status of EMI options during a reorganisation is not straightforward. In our experience, early planning can help identify potential problems and allow the reorganisation to be structured in a way that protects the position of EMI option holders where possible.

Please do speak to us with any questions.