In Part One of this blog series, Kieron Batham-Tomkins, Senior Tax Manager at BHP explored Enterprise Management Incentive (EMI) schemes, how they work and how they could benefit both employees and employers, supported by a worked example.
In Part Two of this blog series, I’d like to move on to how companies and employees qualify for the scheme and briefly cover some of the legal formalities involved. Part Three will then look at the flexibilities the schemes have in relation to exercise criteria and how an EMI can be utilised to exit a company.
Qualifying options
For an option to be qualifying, an employee may not hold unexercised options in respect of shares with a total value of more than £250,000 at the time that the options are granted. See Part One in relation to how shares are valued.
When an employee’s options reach the limit, no further qualifying options may be granted for three years, and then only if some of the other options have been exercised or have lapsed.
The maximum value of EMI options that a company can grant is £3m and the option must be capable of being exercised within 10 years from the date of grant.
The shares that are to be acquired under the option must be fully paid up non-redeemable ordinary shares.
The employee must work at least 25 hours per week on average for the company (or 75% of their working time, if less).
The employee and their associates (eg spouse, parent, grandparent, child, grandchild or remoter relative in the direct line) must not have a ‘material interest’ in the company – broadly speaking, this means more than 30% of its share capital.
Qualifying trades
Companies must carry on a qualifying trade. The term ‘qualifying trade’ is defined as an activity undertaken with a view to the realisation of profits that does not, to a substantial extent, consist of an excluded trade.
Examples of non-qualifying trades are:
- Dealing in commodities, futures, shares and securities
- Dealing in goods other than in an ordinary trade of wholesale or retail distribution
- Banking, insurance, moneylending, debt factoring, hire-purchase financing or other financial activities
- Leasing or receiving royalties or licence fees (subject to certain exclusions)
- Legal and accountancy services
- Property development
- Farming or market gardening, woodlands and other forestry activities
- Hotels, nursing homes or residential care homes
- Shipbuilding, coal and steel production.
Advance Assurance can be sought from HMRC to confirm that the company is carrying on a qualifying trade and is advisable where there is any doubt.
Qualifying companies
Companies must also meet various other qualifying conditions both before and after options are granted as below:
- The company (or group if relevant) must have gross assets of less than £30m.
- The company must not be controlled by another company and there must be no arrangements whereby another company could take control.
- If the company has subsidiaries, they must be 51% owned (except for property managing subsidiaries which must be 90% owned). With small exceptions, the company (or group, if relevant) must not have more than 250 full-time employees and must have a ‘permanent establishment’ in the UK.
While the above conditions may appear to be relatively straightforward, the requirement that there are no arrangements for another company to take control should be considered carefully where the company has investors. For example, some investment agreements can contain “Doomsday” clauses where, in certain scenarios, the investor can gain control. These clauses could be sufficient for HMRC to consider that “arrangements” exist and the company does not qualify.
Where there is any doubt, Advance Assurance should be sought from HMRC before the options are granted.
We are increasingly finding that Advance Assurance is being requested as part of the Due Diligence process on a sale, so even where it is clear that the company qualifies, we are typically recommending that Advance Assurance is sought for a “belt and braces” approach.
Legal formalities
There must be a written agreement between the company and employee, specifying:
- the date of the grant of the options,
- the maximum number of shares over which the options are granted,
- the price at which the shares may be bought,
- when and how the options are to be exercised, and
- details of any restrictions or conditions such as performance requirements.
The value of the shares can be agreed upon with HMRC before the options are granted, and the company must notify HMRC via its online services portal that options have been granted within 92 days of the date of grant.
Notification within the time limit is key, as a late notification will mean that the options are not treated as EMI options and all tax advantages are lost.
An annual return is also required each year, which must be submitted online within three months of the end of the tax year.
For further advice on EMI schemes and whether your company could qualify, contact our Tax team today.
