Private equity deals often involve the shareholders partially exiting a business by receiving a combination of cash, shares and/or loan notes in the acquiring company. Often such deals will involve EMI option holders exercising their options before the transaction and then selling their shares along with the other shareholders. Problems can arise when the option holders think that their affairs are being ‘taken care of’, when in actual fact there are no advisers specifically looking out for them. When the dust settles and they find out that they could have done things better, this can lead to a certain level of resentment which could have been avoided with upfront communication.
EMI options and Business Asset Disposal Relief (‘BADR’)
One message that option holders do generally receive loud and clear is that any gains from their EMI shares will benefit from BADR. This is often correct because of the special EMI status, which means that the normal 5% shareholding conditions do not need to be met. However, when some of the shares are rolled over into shares and loan notes, the resulting assets often will not benefit from BADR on the basis that the special rules do not apply to assets which are derived from EMI shares (they just relate to taxable disposals of the shares themselves).
In 2018/2019, Tim exercised EMI options over 3% of Tradeco’s share capital for £20,000. These shares were then immediately sold within a wider deal for £200,000 of cash and £200,000 of loan notes. Here, he paid tax of £19,000 (10% of (£200,000 less £10,000)) on the cash and rolled the loan notes forward.
The loan notes ended up being redeemed in 2021/22 and Tim wants to know what his tax liability should be. He is somewhat disappointed to be told that he has a £38,000 tax liability in respect of the loan notes (20% of (£200,000 less £10,000)). He was expecting tax of £19,000 (10% of (£200,000 less £10,000)) due to the availability of BADR.
Tim was even more disappointed when it was explained to him that until 31 January 2021, he could have made a section 169Q election to treat the loan notes as taxable at 10% in 2018/2019 – particularly galling as it looked very likely at that point that the loan notes would be repaid……
From our experience, this kind of confusion is common among EMI option holders. They sometimes end up getting things wrong by relying on scraps of advice that are not really applicable to them.
Forbes Dawson view
The above example is just one aspect of deals that option holders should be aware of. We try to encourage the main shareholders to either invite us to engage with the tax issues facing the option holders as a group or, alternatively, to be very clear that they should be seeking their own advice.
Although option holders will generally have no say in the transaction itself, they may have various tax planning opportunities available to them, such as the one mentioned above. Often, strategies adopted by the main shareholders will not be appropriate to option holders, either because the main shareholders will still benefit from BADR on general principles or because it is not an issue for them as they have already used their £1m BADR allowance.
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