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This update sets out some important recent developments relating to the UK's Enterprise Management Incentive ("EMI") regime, which allows the grant of tax-advantaged options by smaller, high growth companies. In summary, the key developments are as follows:
- A reduction in the lifetime limit for Entrepreneurs' Relief ("ER") announced in the Spring Budget has reduced the tax advantages of EMI options.
- Clarification is being sought from HM Revenue & Customs ("HMRC") on a potential risk that employees who are furloughed in order to allow their employers to make use of the Coronavirus Job Retention Scheme, will lose their eligibility to participate in EMI plans.
- More positively, the UK Government has announced a review of the EMI regime, which may improve the tax treatment of EMI options and make them available to some companies that do not currently satisfy the relevant conditions.
More details of these points are set out below. If you would like to discuss any of these points further, please do not hesitate to call your usual White & Case ECB contact.
Changes to Entrepreneurs' Relief
One of the key benefits of the EMI regime is that holders of EMI options automatically benefit from ER when they sell the shares acquired on exercise of their options, without having to satisfy the usual 5% minimum holding limit, as long as they have held their options for at least two years. Since the exercise of EMI options does not usually attract income tax, this means that a higher rate taxpayer only pays (at current rates) tax on gains made through the EMI regime at a rate of 10%. This compares to an effective rate of 42% on ordinary non-EMI options, once you take into account employee's National Insurance contributions (which are not normally payable on EMI option gains).
The Government has announced two changes to ER. The first of these was to rename ER as "Business Asset Disposal Relief". This change came into effect on 6 April 2020 and at least avoids any confusion over where the apostrophe should go after "Entrepreneur". The more significant change was that the lifetime limit on gains eligible for the relief has been reduced from £10 million to £1 million. This limit applies to any qualifying disposals made on or after 11 March 2020. Those who achieve gains above the £1 million limit will not benefit from Business Asset Disposal Relief on the excess.
Whilst the Government's budget estimates that more than 80 per cent of those claiming Business Asset Disposal Relief will be unaffected, many holders of EMI options in high growth companies hope to achieve lifetime gains well above £1m. EMI share options will nevertheless continue to carry significant advantages over their alternatives if, and for so long as, the current margin between capital gains tax rates and income tax rates remains. If capital gains tax rates rise closer to income tax rates (and they have in the past been equal), then they will become commensurately less attractive as a means of recruiting and retaining talent.
COVID-19: Disqualifying event for EMI option holders?
COVID-19 may affect the continued eligibility of employees under the UK's tax-advantaged plans. Amongst other rules, there is a requirement that employees work a certain number of hours in the business in order to qualify for EMI tax treatment. An eligibility issue may arise in a situation where EMI option holders are furloughed and will therefore not be working for their employer.
An employee holding qualifying EMI options could trigger a "disqualifying event" if they are furloughed, because he or she would have no "committed time" as defined in the legislation.
Any such disqualifying event will be taken to occur at the end of the tax year in which failure to meet the committed time requirement occurs. If options are not exercised within 90 days after the end of that tax year, income tax will be due on the difference between the market value at the date of the disqualifying event and the market value at the time of any later exercise.
This is unlikely to be an issue for the 2019/20 tax year, given that the committed time obligation would be calculated by reference to the actual time spent in employment during the year up to 5 April 2020, but it may become important for the 2020/2021 tax year if furlough leave is extended.
The issue has been raised with HMRC and we expect HMRC to publish guidance on the impact of COVID-19 on tax-advantaged share schemes. We would hope HMRC will introduce a concession similar to the one that already exists for EMI option holders who serve as armed forces reservists.
In the meantime, we recommend that companies review the rules of their EMI plans to check that a disqualifying event does not inadvertently result in automatic lapse of options.
Government Review of EMI
In addition to the changes to ER, the Chancellor announced in the Spring Budget a review of EMI, with the aims of ensuring that they are supporting high-growth companies in the recruitment and retention of key talent and examining the extent to which more companies should be able to access the EMI regime. This announcement follows representations by various bodies (including Innovate Finance, an industry body representing the UK FinTech industry and the ESOPCentre). These bodies have proposed changes that include:
- increasing the current value limits on non-vested EMI options from £250,000 to £500,000 per employee over three years and increasing the overall limit on the value of issued options outstanding in the company at any one time from £3 million to £6 million;
- removing or increasing the £30 million Gross Assets Test, which would allow EMI options to continue to serve SME listed and private companies whilst also perhaps enabling EMI options to supplement Company Share Option Plans for larger listed companies; and/or
- abolishing the "working time declaration" as it acts as an unnecessary restriction.
Jonathan Crookham (White & Case, Associate, London) and Frances Snowball (White & Case, Trainee Solicitor, London) contributed to the development of this publication.
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