How to disqualify your EMI in 3 simple ways?
So, you have set up your government approved, tax-efficient share option scheme the EMI. You have implemented it, communicated it to employees and most importantly registered the grant of options with HM Revenue & Customs within the prescribed 92 days from the date of grant. Unfortunately the work is not over.
The EMI legislation lists a number of 'disqualifying events'. If any of these events occur, the favourable tax treatment of the EMI is lost. The option defaults to a tax inefficient unapproved option unless the participant is able to exercise their option within 40 days of the disqualifying event occurring. Therefore EMI eligibility is not just based on a snapshot of the company when the plan is launched but requires on-going monitoring. Below we have set out the 3 most common ways to disqualify your EMI.
Step one: Change your Company Structure
Companies offering EMI options must be independent, that is, not owned by any other company, or by any company together with one or more connected parties. If a company is controlled by a partnership it will not fail the independence test as long as none of the partners are companies. If a company owns exactly 50% of another company, the normal presumption is that the second company is controlled by the first together with persons connected with the first company. HM Revenue & Customs takes the view that, in a complete deadlock situation, the company could not be run at all unless the shareholders were prepared to co-operate. This co-operation would be sufficient to make the shareholders connected parties for the purposes of the legislation. However, in specific cases it has been possible to show to the satisfaction of HM Revenue & Customs that there is no active co-operation, that the shareholders are not connected for tax purposes and that the company therefore remains independent. A company will also fail the independence test if there are any arrangements whereby, at some point in the future, it could come under the control of another company or another company and its associates. This could include situations where a minority venture capital investor has an option to acquire a controlling stake if certain performance criteria are not met. In a group situation it is also necessary to ensure that subsidiary companies remain qualifying subsidiaries. Entering into a joint venture can also cause problems.
Step two: Change your trading activity
Company activities that preclude eligibility for EMI include property development, financial activities such as banking, insurance and leasing, including the leasing of property; legal and accounting services, farming, the operation or management of hotels and nursing homes, and dealing in land, securities or other assets. The trap for the unwary is not if you change your trading activity completely, as that is a little unusual, but if you start another activity alongside your main activity. For example, a company trading as an advertising agency (a qualifying activity) may have accumulated surplus profits over a period of years and invested them in bonds. Over time, the value of these bonds, and the income from them, may come to represent a not insignificant amount of the company's assets and/or income. HM Revenue & Customs may then argue that the company's corporate treasury activity now means that it is in part an investment company, and therefore non-qualifying. The rules about this are complex and a different test applies to a group than a stand alone company.
Step three: Change the hours that you work
Participants must work at least 25 hours per week for the sponsoring company, or 75% of working time if less. An employee could in theory work 25 hours per week for more than one employer and thus be able to participate in more than one EMI scheme. It is also possible for someone who works on only one day a week to qualify for participation in an EMI scheme, if that day is the only day on which the person works and they have no other employment. If an employee's working hours fall below the above requirements this will be a disqualifying event.
Other points to note!
Although the following will not disqualify any existing EMI awards they will prevent you from being able to grant any new EMI options or, in the case of the third point, cause potential tax complications:
- Reaching the 250 full time employee limit
- Exceeding £30 million gross assets
- Amending your Articles of Association especially the share rights, as this affects the value of the options
Unfortunately the above is not an exhaustive list and there are many traps for the unwary. Often problems only come to light as part of a due diligence process at exit, when it is often too late to take remedial action.
RM2 provide the full share scheme offering including share scheme health checks and administration services. Please call 020 8949 5522 to discuss your requirements and let us help you ensure your plan remains compliant.
1. Finance Act 2013 has now extended this deadline to 90 days.