Don’t get disqualified: how to check your EMI

Companies that operate EMI options, and employees participating in EMI schemes, benefit from significant tax reliefs. However, companies should be aware that there are a number of events that can cause the options to become disqualified, resulting in a potential loss of the tax reliefs.

Tax reliefs

Provided the EMI options are granted at market value, there will be no income tax on grant or exercise of the option. Instead, capital gains tax will be paid on the sale of the resulting shares (usually reduced by the application of entrepreneurs’ relief). The employing company will usually also qualify for a corporation tax deduction equal to the gains made by the employees when the option is exercised.

Effect of disqualifying events

However, the EMI option must qualify for these reliefs by satisfying specific statutory requirements. A number of changes or developments can disqualify an option from EMI relief. These are called disqualifying events. A disqualifying event can restrict tax relief so that the option becomes subject to income tax rather than the more favourable capital gains tax treatment. There is no effect if an option is exercised within 90 days of the disqualifying event. If the option is exercised more than 90 days after the disqualifying event, the gains in excess of the market value of the shares at the time of the event are subject to income tax (and PAYE and NICs if the shares are readily convertible assets at the time of exercise).

Examples of disqualifying events

There are two types of disqualifying events – those that relate to the Company and those that relate to the option holders. It is very important to be aware of when these might happen. Common examples are changes to the company’s articles of association, which could impact on the value of the shares under option; changes to participant’s employment status meaning that they are no longer an eligible employee; company reorganisations or the introduction of new investment agreements which could mean the company no longer satisfies the independence test.