Enterprise Management Incentives (‘EMI’) are a very tax efficient way of rewarding key employees with equity based rewards. Under EMI, employees are able to be granted with options (often at a high discount) which are typically linked to a future ‘exit event’ (sale, listing etc.). At exit, the employee is able to exercise their option and receive a share of the proceeds, with any ‘profit’ – assuming the option price was set at a market value when issued – being subject to the (lower) rates of capital gains tax.
One of the conditions which the issuing company must meet is the “independence” requirement. This broadly requires that the company must not be controlled by another company. However, the actual wording of the legislation is that the company must not be under the control of another company or “another company and any person connected with that company”. The definition is unique to EMI and could potentially create a nasty trap …
We recently came across a company (let’s call it Jones Ltd) which had a majority shareholder (Tom) owning 60% of the shares, and a partnership (which the shareholder was also a member of with a majority interest) owning the other 40%. Clearly with no corporate shareholders the independence requirement was satisfied and EMI options were granted to key employees. A year later the partnership incorporated into Delilah Ltd, with Tom holding 80% of the shares. Because Tom is connected with Delilah it was thought that the independence condition might be breached because Tom and Delilah Ltd control Jones Ltd.
Fortunately, in this case, HMRC have expressed the view that the independence requirement will not be seen to have been breached because Tom continues to own more than 50% of the shares in the EMI company personally (he could control the company without the help of Delilah Ltd). However, there would be issue in a situation where a controlling shareholder transfers some of their shares to a personal holding company and does not retain a majority interest. It would also affect a scenario where a shareholder wishes to transfer shares (which take him below 50%) into trust and the trustee is a company.
The take home message is that companies with EMI schemes need to be mindful of how changes to their activities or shareholder structure can affect their status. If the EMI conditions are breached this could potentially be very costly, as the options will no longer qualify for the benefits of EMI.
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