Ensuring your EMI share options qualify

In this article we're going to cover the pitfalls to avoid when ensuring your EMI share options qualify for the tax incentives we've mentioned previously.

Ensuring your EMI share options qualify

There are number of hurdles to overcome when ensuring your EMI share options qualify and these are set out below.

Does your company qualify?

Your company can be quoted or unquoted, though it must fulfil the following conditions detailed below:

  • It must be independent and not a 51% subsidiary of another company or controlled by another company or a company and persons connected to it. Arrangements must not exist which could cause the company to become a 51% subsidiary.
  • The company has gross assets of less than £30 million.
  • It has fewer than 250 full-time equivalent employees.
  • Has only qualifying subsidiaries. The company must hold more than 50% of the ordinary share capital of any subsidiary companies. Joint ventures can sometimes be problematic.
  • Have a permanent establishment in the UK. This is generally, a fixed place of business or an agent concluding contracts on its behalf where the activities carried out are not, as a whole, preparatory or auxiliary in nature.
  • Satisfy the qualifying trade test. It must exist wholly or mainly for the purposes of carrying on a qualifying trade or be preparing to do so. A qualifying trade is a trade carried on wholly or mainly in the UK on a commercial basis with a view to profit that does not consist, to a substantial extent, of certain 'excluded activities' - this was discussed in our previous post.
  • If the qualifying company is a parent company then at least one of its qualifying subsidiaries must meet the qualifying trade test and have a permanent establishment in the UK. IT is always a good idea to obtain Advance Assurance from HMRC if you want to be confident of ensuring your EMI options qualify. 

Qualifying shares

The shares that are covered by the EMI options must be fully paid-up, non-redeemable ordinary shares in the company. Any restrictions attaching to these shares must be notified to participants in the EMI share option agreement/or EMI share option agreement linked to the company's articles.

Qualifying options

The EMI Options must be granted for commercial reasons in order to recruit or retain an employee and not as part of a tax avoidance arrangement. The terms of any EMI share option agreement must be included in a written agreement. 

Limits

The total market value of shares subject to an unexercised EMI option at any time cannot exceed £250,000 per employee. Market value is measured at the time of grant for these purposes. It always prudent to agree a valuation with HMRC beforehand by submitting the form VAL231,

If you or your employees have any unexercised options granted prior to the setting up the EMI share option scheme, these count towards the limit. Once the limit is reached, options may not be granted to the individual within three years of the grant of the last option.

Any number of employees may hold EMI options but the total market value of all shares subject to unexercised EMI options granted by the company or group (determined at the date of grant) cannot exceed £3 million at any time.

Standard terms

The options must be non-transferable, capable of being exercised within 10 years of grant and may not be exercised more than a year after death.

The EMI share options may be granted at any exercise price or for a nil exercise price and the main terms of the option must be specified in a written option agreement

Bespoke terms

These are scheme terms that are specific to each scheme and not dictated to by the legislation. Typically they cover the issuing of shares over time specifically to an employee (know as vesting), They will ensure that share options automatically vest on the occurrence of a sale to a third party or an AIM listing on the London stock exchange or other recognised stock exchange.

Vesting may be deliberately postponed. For example, EMI plan rules may state that your employee is not permitted to take up their options until they have completed a specified number of years service. Alternatively, you could include other performance conditions though this potentially increases the complexity of drafting the scheme.

Some EMI option agreements can include discretionary clauses giving the company the ability to amend the EMI option after grant. However great care should be taken when doing this to ensure that any changes do not cause the EMI options to be non-qualifying (and thus income tax and NIC being due on exercise).

Qualifying employees

Ensuring your EMI share options qualify also involves issuing them to eligible employees. Essentially there are two conditions that your employees need to fulfil.

Firstly your employee cannot control, directly or indirectly, more than 30% of the ordinary share capital of the company. The holdings of any of their associates are also taken into account for the purposes of this 30% test.

Secondly your employees must work for your company for at least an average of 25 hours per week or, if less, 75% of their working time.

Disqualifying events

If a disqualifying event occurs when the company fails to fulfil the qualifying conditions then essentially the exercise of any EMI option will be subject to income tax and NIC. The following are disqualifying events:

  • Your company loses its independence, it is controlled by another company, or by another company and a connected person.
  • The company’s trading activities change to include restricted activities, or it mainly trades abroad.
  •  An option holder ceases to be an employee.
  • Your employee's working hours reduce to less than 25 hours per week or below 75% of their working time.
  • Changes are made to the terms of the option.
  • You alter your company's share capital.
  • The company’s shares are converted.
  • A further grant of share options takes the option holder over the £250,000 limit.
  • Shareholders leave which result in an EMI option holder having more than 30% of your company's share capital

Other potential pitfalls

Typically other events that might cause EMI share options to be non-qualifying are as follows:

  • If another company invests in the your company it may fail the independence test as it may fall under the control of another company (refer to the heading 'Does your company qualify?' above).
  • Some institutional investors' e.g. private equity, might amend a company's articles so that they contain provisions allowing the investor to take control if financial performance is not up to standard. This again can fail the independence test.

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].

Alternatively, please feel free to complete our Business Questionnaire here.

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