Loss of Tax Relief by Disqualification: A Cautionary Tale

One of the tests for a company to qualify for EMI share schemes is that it is not “a 51% subsidiary” of another company – i.e. no more than 50% of the company’s share capital is owned directly or indirectly by another company. This test must be met both at the time the options are granted, and throughout the life of the option.

If this situation changes at any time, the options will become “disqualified” and the tax reliefs lost.

It is therefore of great importance that you remain aware of corporate transactions that might cause a disqualifying event.

Recent Case

A recent case concerning EIS relief (the relevant test here is identical to that for EMI) demonstrates this (Finn v Revenue & Customs Commissioners (2015 UKFTT 0144(TC)).

PhotonStar Limited satisfied the rules for EIS relief and a number of investors had obtained tax relief on that basis.

PhotonStar sought a listing on AIM by way of a “reverse takeover”: they identified an appropriate AIM listed company, Enfis Group plc, and entered into an arrangement whereby Enfis technically acquired all the share capital of PhotonStar, but the shareholders, management and business of Enfis afterwards was broadly that of the acquiree. Enfis at the time of the takeover would also have qualified for EIS relief.

HMRC informed PhotonStar that, because it had come under the control of Enfis, the company no longer met the legislative requirements for EIS.

PhotonStar argued that it had not become a 51% subsidiary. They said that this was because, even though the transaction took the legal form of an acquisition by Enfis, it was in substance a takeover of Enfis by PhotonStar. In addition, Enfis and PhotonStar were, in effect, a single company because the two of them together acted as a single legal entity, being the same economic unit and carrying on the same business.

Perhaps unsurprisingly, the First Tier Tribunal disagreed. On the facts, Enfis had on the date of the reverse takeover become the owner of all the shares in PhotonStar. The argument that the two companies together formed a single “body corporate” rather flew in the face of a test that is clear and well recognised in many areas of tax law. In addition, although there is an exception for share for share exchanges in the EIS legislation, this was not an internal reorganisation – and indeed, some 22% of the share capital of Enfis after the takeover was still held by original Enfis shareholders, rather than the PhotonStar shareholders.

Therefore, PhotonStar had indeed become a 51% subsidiary of another company, and so the EIS relief was lost.

The case may be appealed but the principle remains that you should be very clear about any changes in the ownership of your company which may inadvertently lead to loss of tax reliefs, including disqualifying events for EMI.