HMRC updated guidance on Entrepreneurs’ Relief for EMI option shares
What's the new view?
On 2nd October 2013 HMRC updated its Capital Gains manual. Amendments included guidance on the special Entrepreneurs' Relief provisions for shares acquired on exercise of Enterprise Management Incentive options on or after 6th April 2012. This new guidance makes clear HMRC's view of the effect of the transitional provisions for shares acquired under EMI in tax year 2012/13. HMRC considers these apply only to disposals of shares on or after 6th April 2013, even if disposals of shares of the same class took place in 2012/13 and an election is made to apply the transitional provisions to shares acquired in that year. As a result, the benefit of the relaxed requirements will only be available in respect of shares acquired in 2012/13 to the extent that a taxpayer holds shares of the same class at 5th April 2013 and subsequently makes a disposal.
The new test
Changes introduced by Finance Act 2013 increase the scope for an employee to claim Entrepreneurs' Relief (ER), for Capital Gains Tax (CGT) purposes, on a sale of shares acquired as a result of exercising an Enterprise Management Incentive (EMI) option. To qualify for ER, the shares must be "relevant EMI shares", that:
have been acquired on exercise of a qualifying EMI option - shares do not count if they are acquired more than 90 days after an EMI disqualifying event (or 40 days, if options are exercised before 17th July 2013); and have been acquired since 6th April 2012, but for shares acquired before 6th April 2013 (i.e. in tax year 2012/13) there are transitional provisions that must be satisfied (discussed below).
Additionally, to qualify for ER, the relevant EMI shares must be sold, or disposed of, at least one year after the option grant date; and throughout that one year period the company is a trading company (or holding company of a trading group), and the individual is an employee or officer of the company (or a company in the trading group).
These changes represent a significant improvement upon the previous rules applying to ER. This is because many employees were unable to satisfy the "personal company" requirements which previously needed to be satisfied for ER eligibility. (These included a requirement for the individual to hold 5% of the ordinary share capital and 5% of the votes in the relevant company for a period of at least a year, ending with the date of the disposal).
New share identification rules
Finance Act 2013 has also changed the CGT share identification rules that apply to the disposal of shares of the same class acquired by individual taxpayers in the same capacity on or after 6th April 2013, as follows:
first, with shares acquired on the same day, relevant EMI shares will be treated as disposed of after the remainder of such shares; second, with shares acquired within the period of 30 days after a disposal, relevant EMI shares will be treated as acquired after the remainder of the shares acquired in that period, and subject to that, with shares acquired at an earlier time in that period rather than with shares acquired at a later time in that period.
Shares identified with relevant EMI shares under the identification rules will not form part of a "share pool" under section 104 TCGA 1992.
Finance Act 2013 has also introduced transitional provisions for shares acquired on exercise of EMI options in tax year 2012/13. These provisions might assist taxpayers obtain the benefit of ER on the disposal of EMI shares, but only if they held shares at the end of tax year 2012/13 and dispose of those shares subsequently (the transitional provisions are outlined below).
Did you sell too soon?
If the taxpayer sold all his/her shares in tax year 2012/13, there is no opportunity under the transitional provisions, according to recent HM Revenue & Customs guidance, for the taxpayer to take advantage of the revised ER rules for CGT purposes. For example, if a takeover or share sale took place in that tax year, and the employees exercised their EMI options on such event and immediately sold the shares. This is understandably harsh for those affected by the timing of when they acquired/disposed of their shares not coinciding with the transitional provisions as to date of share acquisition/disposal.
The transitional provisions applying to EMI shares acquired during tax year 2012/13 are as follows:
if the individual taxpayer did not dispose of shares of the same class during tax year 2012/13, the EMI shares will be treated as relevant EMI shares that may qualify for ER; if the individual taxpayer disposed of shares of the same class as the EMI shares during tax year 2012/13, the taxpayer may make a tax election for the EMI shares acquired in that tax year to be treated as relevant EMI shares that may qualify for ER.
Where a tax election is made the identification rules will apply, as follows:
first, shares disposed of in tax year 2012/13 will be identified with shares that are not relevant EMI shares; andsecond, with relevant EMI shares acquired at a later time, rather than with relevant EMI shares acquired at an earlier time.
The time limit for making or revoking such a tax election is 31st January 2014 (the filing date for the 2012/13 tax return).
Why was the clarification needed?
The Finance Act provisions amending ER as it applies to EMI options are not very clear. Many taxpayers (and some non-specialist advisers) are likely to have taken the view that the transitional provisions could be construed to benefit disposals in 2012/13. However we now have published guidance from HMRC clearly stating that, in their view, that is not the case and only disposals of shares after 5th April 2013 will benefit.
The trap that some may have fallen into (and why perhaps more people were not advised to defer share sales into 2013-14 whenever possible) is the Finance Act 2013 wording that provides for elections for EMI option shares acquired in 2012/13 to be "treated as if" acquired on or after 6th April 2013. However, crucially, the Act does not state expressly that the equivalence of the treatment extends to disposals of such shares in tax year 2012/13. Instead, Finance Act 2013 expressly states that the amendments apply only for disposals on or after 6th April 2013 (para 5, Schedule 24, FA 2013).
There may be some readers who are now concerned about the tax bill they are facing for 2012/13 and the larger than expected CGT payment they will now need to make on 31st January 2014. The timing of share disposals cannot always be deferred but this is a cautionary tale that highlights the need for specialise advice on share scheme matters, especially around transactional events. An understanding of the new share identification rules will be needed in order to optimise any planning opportunities and timing of events in future for those with EMI options approaching an exit.
RM2 provides specialist advisory support in relation to the numerous considerations that need to be borne in mind and managed when a business is being sold to ensure that the desired benefits to be delivered under any share schemes are not inadvertently negatively impacted.
For further information about the new transitional ER and EMI provisions please contact Anthony Metcalfe-Gibson or any member of the RM2 team on 020 8949 5522. If you selling your company and would like a quote for advisory support in relation to the share plan administration aspects please also get in touch by emailing firstname.lastname@example.org.