Be careful - a trap for the unwary - the loss of tax advantages
In certain circumstances, making changes to an existing Enterprise Management Incentive option can culminate in the removal of all the tax benefits usually attaching to EMI.
An EMI option is granted by way of an option agreement – so it forms a contract between the person granting the option (usually the company) and the option holder.
Of course, it’s usually possible to amend contracts if both parties agree. But because of the tax advantages attached to EMI options, HMRC will often look askance if the agreement is changed after it’s been signed. In the worst-case scenario, HMRC will view the changed option agreement as a completely new option grant.
That can have a couple of outcomes:
- Entrepreneurs’ Relief: The original date of grant will be replaced with the date of the regrant. Because the entrepreneurs’ relief that attaches to EMI options will only apply if the options have been held for at least 2 years before the sale of any shares acquired under the option., the new grant of an option will “restart the ER clock”. That could have a significant impact on the option holder if the company is sold within two years of the new date of grant.
- Income tax/NICs relief: If EMI options are granted with an exercise price set at the market value of the shares at the date of grant, there should be no income tax or National Insurance Contributions charge (“Tax Charge”) when the option is exercised. However, if the shares’ market value has increased between the original date of grant and the regrant date, but the exercise price remains the same, then a Tax Charge will apply on exercise, based on the effective discount to market value.
Worst case scenario: complete loss of EMI tax treatment
Of course, these two points are potentially manageable if the company and the participant know about them and are forewarned.
However, if the changes are made without realising that they amount to a new EMI grant, the outcome may be worse. If HMRC consider that a new grant has been made, they will expect that new EMI option to be registered within the usual 92 day deadline.
Failing to register the new EMI option in time will mean that the option does not qualify for the EMI tax treatment at all. Thus, on exercise, the option will be taxed as a non-tax advantaged options with all gains subject to income tax (and potentially NICs).
Companies that have existing EMI option grants and wish to change aspects of the agreements – including changes to performance conditions – should take advice before doing so, or risk the loss of the beneficial tax treatment.
If you need help with EMI options or any other employee share scheme, please contact us for a free consultation on 0208 949 5522 or email email@example.com