Great news for EMI but proceed with caution!
It didn't make the newspaper Budget headlines but the Treasury Budget press release contained some exciting news about imminent enhancements to Enterprise Management Incentives (EMI).
From a date that is yet to be announced, the upper limit on the value of shares that can be offered to an individual under an EMI scheme will increase from £120,000 to £250,000. This is exceptionally good news and will allow more executives to take their rewards in a tax-efficient manner and should encourage more wide-spread employee equity participation. The change will be made by statutory instrument, as soon as possible, subject to State Aid approval. This welcome news also demonstrates the government's continuing support for this important and attractive incentive.
In this regard, it is worth remembering that an EMI valuation agreed with HMRC Shares and Assets is usually valid for a 60 day period. This means that if an award is made whilst the limit remains £120,000 but the uplift to £250,000 takes effect prior to the end of the valuation agreement window then it could be possible to grant further top-up awards with minimum additional cost, far better than delaying an award altogether and risk losing key talent in the intervening period.
The good news did not stop there. Additional EMI reforms will feature in Finance Bill 2013 (not, sadly, in the Finance Bill 2012 currently before Parliament) with a view to enabling gains made on shares acquired through exercising EMI options on or after 6th April 2012 (i.e. in the current tax year) to be eligible for Capital Gains Tax (CGT) Entrepreneurs' Relief (thus reducing the effective rate of tax to just 10%). Speculation was rife as to what changes would ensue and further guidance on this was published on 29th March 2012 stating that shares acquired pursuant to an exercise of EMI options on or after 6th April 2012 will be eligible for Entrepreneurs' Relief regardless of the quantum of the interest (i.e. a plan participant will not need to have a 5% interest in the voting share capital) provided the shares are held for one year prior to sale.
It will be absolutely essential for companies to take specialist advice on this matter. In particular, many advisers will be quick to point out that if an EMI plan operates as an exit only exercise plan then Entrepreneurs' Relief will not be possible as the one year holding period as a shareholder (not option holder) will never be met. It is worth considering facilitating the possibility of Entrepreneur's Relief (and thereby an effective rate of tax 10% [rather than 28%] on gains realised) for EMI option holders by allowing exercise at an earlier vesting point for any new options. It may also be appropriate to replace existing options to obtain a tax optimised arrangement and deliver the best incentive.
BUT beware simply tweaking the Option Agreement terms relating to the ability to exercise new options and failing to consider what happens if a participant exercises but then leaves employment prior to exit. The specialist adviser will anticipate this at the outset and will have the share scheme, tax and company law expertise to ensure that before any award is made the necessary commercial protections are also put in place in the Company's Articles.
In reality, however, most option plan participants choose not to exercise their options until exit in order to be secure of funds to pay the exercise price and remove investment risk that otherwise arises when they invest exercise money to acquire shares without any imminent prospect of a market to sell their shares at a profit. Here the adviser's skill in successfully negotiating a favourable share valuation with HMRC Shares and Assets Valuation will be key to determining the level of investment risk and affordability of exercise for a participant. Time will tell if HMRC SAV start to take a more robust stance in relation to the discounted valuations sought.
Where a Company currently has an exit-only exercise EMI plan the Board may wish to reflect on this in light of the above. If new awards need specialist advice then so do amendments to existing awards. Any variation of the terms of an existing option may have unexpected and unwelcome consequences if the proper advice is not taken. The new guidance is welcome in so far as it clarifies that a 5% interest will no longer be needed but remains unsatisfactory as it does not yet have statutory force and remains therefore subject to change.
As if all of that was not enough, there will also be consultation on ways to extend access to EMI for academics who are employed by a qualifying company and this looks likely to benefit young businesses at the research and development stage of their operations.
It certainly looks like there has never been a better time to consider an EMI plan or take a fresh look at an existing plan. If you would like more information about the benefits of share schemes, including EMI, or the impact of the Budget on your share plan then please call us on 020 8949 5522 or email Liz Hunter on Liz.Hunter@rm2.co.uk.