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Business Tax  •  Personal tax

Ensure your company reorganisation doesn’t impact its EMI eligibility

By RJP LLP on 13 April 2022

Enterprise management incentive (EMI) options are popular with SMEs because they are highly tax advantaged. Providing that the relevant conditions are met, no tax is payable when options are granted or exercised, and the qualifying period for business asset disposal relief (BADR) begins on the date on which the options are granted, rather than when they are exercised, and the shares are actually acquired.

The qualifying conditions for BADR to apply for EMI option holders also provide that, unlike other shareholdings, it is not necessary for the shareholder to have a minimum 5% shareholding.

Entitlement to BADR means that the first £1m of gains on disposal of the shares are taxed at a capital gains tax rate of 10% rather than 20%.

As with everything in the world of tax there are always caveats and option holders will experience difficulties retaining the many benefits of EMI if a disqualifying event occurs. This can happen without their knowledge and an income tax liability can be triggered if the options are not exercised within 90 days of a disqualifying event. Many company directors are not aware of all the conditions which must continue to be met and as a result they can be inadvertently breached. This article outlines some of the pitfalls.

The following are potential disqualifying events for EMI option holders:

  • The company in which EMI options have been granted becomes a 51% subsidiary of another company;
  • The company in which EMI options have been granted ceases to meet the ‘trading activities’ requirement;
  • The employee holding EMI options ceases to be an eligible employee; this can occur if they cease to meet the qualifying working hours requirement, or they cease to be an employee of the company;

Given that the recent pandemic has caused so much disruption, lots of companies are restructuring and reorganising their business interests, which could trigger a disqualifying event. For instance, capital reduction demergers which may involve a new holding company, share-for-share exchange transactions and also outright business sales are more common.

In some instances when a company is bought by a third party, the purchaser will intentionally want to unravel the EMI option scheme, so any former options will be exercised before the sale. This is typically well planned and in most cases the option holders do not miss out.

However note:

  • If the acquiring company does not offer replacement options, the original EMI options must be exercised within 90 days of the acquiring company obtaining control in order to preserve the tax benefits;
  • If options have already been exercised by the date the acquiring company obtains control and the original option holder is given shares in the acquiring company, the new shares may in certain circumstances continue to be treated as EMI shares and retain their capital gains tax advantages.

Other restructuring situations can be more problematic. For example, if a company reorganisation takes place but the original shareholders and management team remain in place, the original EMI options may be disqualified.

If your company has granted EMI options and is undertaking a restructuring exercise, we recommend taking advice from a tax specialist who has experience of EMI to ensure the option holders don’t lose out on valuable tax relief.

If you want to discuss EMI schemes and eligibility in more detail, please contact us at partners@rjp.co.uk

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Enterprise management incentive (EMI) options are popular with SMEs because they are highly tax advantaged. Providing that the relevant conditions are met, no tax is payable when options are granted or exercised, and the qualifying period for business asset disposal relief (BADR) begins on the date on which the options are granted, rather than when they are exercised, and the shares are actually acquired.

The qualifying conditions for BADR to apply for EMI option holders also provide that, unlike other shareholdings, it is not necessary for the shareholder to have a minimum 5% shareholding.

Entitlement to BADR means that the first £1m of gains on disposal of the shares are taxed at a capital gains tax rate of 10% rather than 20%.

As with everything in the world of tax there are always caveats and option holders will experience difficulties retaining the many benefits of EMI if a disqualifying event occurs. This can happen without their knowledge and an income tax liability can be triggered if the options are not exercised within 90 days of a disqualifying event. Many company directors are not aware of all the conditions which must continue to be met and as a result they can be inadvertently breached. This article outlines some of the pitfalls.

The following are potential disqualifying events for EMI option holders:

  • The company in which EMI options have been granted becomes a 51% subsidiary of another company;
  • The company in which EMI options have been granted ceases to meet the ‘trading activities’ requirement;
  • The employee holding EMI options ceases to be an eligible employee; this can occur if they cease to meet the qualifying working hours requirement, or they cease to be an employee of the company;

Given that the recent pandemic has caused so much disruption, lots of companies are restructuring and reorganising their business interests, which could trigger a disqualifying event. For instance, capital reduction demergers which may involve a new holding company, share-for-share exchange transactions and also outright business sales are more common.

In some instances when a company is bought by a third party, the purchaser will intentionally want to unravel the EMI option scheme, so any former options will be exercised before the sale. This is typically well planned and in most cases the option holders do not miss out.

However note:

  • If the acquiring company does not offer replacement options, the original EMI options must be exercised within 90 days of the acquiring company obtaining control in order to preserve the tax benefits;
  • If options have already been exercised by the date the acquiring company obtains control and the original option holder is given shares in the acquiring company, the new shares may in certain circumstances continue to be treated as EMI shares and retain their capital gains tax advantages.

Other restructuring situations can be more problematic. For example, if a company reorganisation takes place but the original shareholders and management team remain in place, the original EMI options may be disqualified.

If your company has granted EMI options and is undertaking a restructuring exercise, we recommend taking advice from a tax specialist who has experience of EMI to ensure the option holders don’t lose out on valuable tax relief.

If you want to discuss EMI schemes and eligibility in more detail, please contact us at partners@rjp.co.uk