Discretion and EMI share options

We recently blogged on HMRC’s update on the use of discretion in relation to the exercise of EMI share options (HMRC publish guidance on exercise of discretion in relation to EMI options – The RM2 Partnership).  Lots of companies want to make the most of the inherent flexibility of EMI options, but getting it wrong can be costly, and may lead to losing all the tax advantages offered by EMI options, so here’s a little more detail on the topic.

EMI – discretion on the exercise of options

The Enterprise Management Incentive Plan (or EMI) is a very flexible scheme.  For example, there is no set rule about when EMI options can be exercised.  So you might allow options to be exercised after six months, without any other conditions applying; you might choose to set performance conditions so that options could only be exercised if certain targets had been met after a certain time; or you might say that options could only ever be exercised if the company was sold.


Assume you are the owner of a restaurant business.  You granted EMI options to your commercial director, Louise, in January 2020.  As a condition of those EMI options Louise must increase turnover in the restaurants by 100% over the next 4 years.  If she does, she can then exercise all her options on or after the 5th anniversary of the date of grant (January 2025).  If the target isn’t met, the options lapse on the 5th anniversary. 

Covid hits, but the business survives, and by January 2023 Louise has pulled the business back onto an even keel.  That’s a huge achievement – but the original target is little more than pie in the sky (excuse the pun) and it certainly won’t be achieved by 2024. There are certain discretions afforded to you within the EMI Plan as the sole director. Have you got the flexibility to ensure that Louise can be rewarded appropriately, even though she’s not met the specified targets?

Applying discretion on EMI options successfully

This will depend largely on how the original EMI agreement or Plan Rules were drafted.  The questions below will help you decide whether there is scope to flex Louise’s option:

1. Is discretion, and the ability to amend Louise’s targets, included in the original agreement/EMI Plan Rules?

If the EMI option agreement/Rules just state the performance conditions and the lapse date, with no reference to applying discretion or amending the targets, then it will be virtually impossible to change the conditions after the event. Any such change will most likely be seen as the grant of a new option with loss of any tax breaks/accrued value on the original options.

2. If there is a discretion, how wide is it?   

Any option must give the option holder a right to exercise the option.  A very wide discretion, that is effectively at the whim of the board, does not give the option holder an actual right to exercise.  Therefore, a “catch-all” or unlimited discretion that isn’t linked to a particular triggering event but that allows the options to be exercised at any time to be decided by the board is unlikely to be acceptable, irrespective of the performance conditions. 

3. Are the proposed changes “fair and reasonable?

If the original agreement/EMI Plan allows it, you can amend – or even waive – the original performance conditions, provided that it is “fair and reasonable” to do this. 

In the circumstances, it is highly likely that amending targets in the restaurant sector during the pandemic will be reasonable.  However, do make sure that you record your reasoning behind the decision (e.g. in a board minute) and follow the process outlined in the option documentation to give effect to the changes (including notifications to impacted option holders).  Ideally, your new target should be no more difficult to achieve than the original one – certainly, it should be measured objectively.

4. When would you like Louise to exercise her options?

Unless the original agreement/Plan Rules allow options to be exercised early in certain circumstances, you should not allow Louise to exercise her options before the original 5 year timeline. HMRC will not accept any exercise of discretion that brings the original date of exercise forward (unless there are specific references to an event on which there can be accelerated vesting, for example, for an exit event or good leaver circumstance).

What if you get discretion on EMI options wrong?

If you apply discretion to EMI options when no discretion is permitted, or if you apply discretion wrongly, this will be seen by HMRC as the grant of a new option.  This has three key consequences:

  • Loss of certain capital gains tax (CGT) benefits.  The beneficial CGT treatment for EMI options is measured from the date of grant of the option.  If you grant a new option, therefore, you will be restarting the “CGT clock”.  Your commercial director will have to wait for 2 more years before she can benefit from business assets disposal relief (previously known as entrepreneurs’ relief) on the sale of her EMI shares.
  • Rebasing the value of the shares. The deemed grant of the new option will “rebase” the valuation of the underlying shares to the date when the discretion is used (rather than the original 2020 valuation). If the value is higher now than in January 2020, Louise will either have to pay that increased value for her shares or suffer an income tax (and potentially National Insurance liability) on the discount when she exercises the option. There may also be employer’s NICs for the company to pay on that discount.
  • Failure to qualify as EMI option at all.  The grant of a new EMI option will require notification to HMRC.  Of course, if you’re not aware that you’ve exercised discretion wrongly, you probably won’t even realise you’ve granted a new option.  That means you won’t think about registering it – and a non-registered EMI option won’t qualify for any of the EMI tax breaks, but will instead be taxed (income tax & NICs) on exercise as a non-tax advantaged option.

How RM2 can help?

It’s helpful that HMRC have clarified the position but exercising discretion even with the guidance to hand is not always straightforward and there are some grey areas.  Companies that are granting new EMI options should take due care when drafting discretionary clauses and have one eye on HMRC’s guidance.  Furthermore, it may be sensible to review existing EMI options to check that any existing discretions meet with HMRC’s requirements, and to seek advice when any exercise of a discretion is contemplated.

If you have any questions on discretion and EMI options please email enquiries@rm2.co.uk to arrange a discussion with our experienced share plans consultants.