Care needed when exercising discretion in Enterprise Management Incentive (EMI) Schemes

HMRC has issued new guidance regarding the use of discretion within tax-advantaged incentive plans, in particular, Enterprise Management Incentive (EMI) Schemes.

New guidance particularly applies to EMI schemes, but it is believed by many to apply to similar statutory share and option-based plans that provide a tax advantage to businesses.

If you operate any of these schemes or share options within your business, it is important to be aware of these changes and to take professional advice – many schemes UK-wide are likely to be affected, and whether set up by an accountant, solicitor or share scheme boutique firm, we recommend that advice is sought.

Discretion clauses in share option documents are very common. HMRC’s recent guidance and interpretation of the exercise of discretion represents something of a change of emphasis and could in some circumstances lead to significant tax liabilities arising, if not considered early.

What is a discretionary clause?

Discretion clauses are predominantly incorporated into Enterprise Management Incentive (EMI) schemes and similar share plans as follows:

  • Good and Bad Leaver Provisions: These provisions grant the Board of Directors the necessary flexibility to make informed decisions on how to treat employees leaving the company, whether under favourable or unfavourable circumstances and tailor appropriate outcomes based on the unique circumstances surrounding each leaver.
  • ‘Exit Only’ Plans: These allow Boards to determine the precise timing when options can be exercised, specifically in relation to significant corporate events. This flexibility ensures that the timing aligns with the company’s strategic objectives.
  • Performance and Vesting Conditions: These clauses empower the Board to adapt to changes in circumstances or corporate events that may affect the achievement of predefined targets. This ensures that the conditions remain fair and relevant, reflecting the evolving dynamics of the business.

These provisions enable directors to navigate complex situations and make decisions that are in the best interest of the company and its stakeholders.

However, exercising discretion in certain ways could lead to the loss of tax advantages associated with these awards.

Consequently, directors must exercise extreme caution when utilizing any discretion provided within EMI schemes.

HMRC’s latest guidance

HMRC has acknowledged that the inclusion of discretion within EMI schemes is acceptable and should not jeopardise the options’ tax-efficient qualifying status.

However, it is essential to note that HMRC’s guidance also emphasises that the manner in which discretion is exercised can, in certain circumstances, create problems and result in the loss of the tax-efficient (qualifying) status of EMI options.

According to HMRC, while some uses of discretion may be deemed acceptable, they will not be accepted if such discretion:

  • Accelerates the timing of when an EMI option can be exercised.
  • Grants the grantor the right to determine when an option can be exercised.

There are other examples within the guidance of circumstances which HMRC consider to be problematic.

In a number of the above cases, HMRC will treat the director’s exercise of discretion as if it were the lapse of the original option and the re-grant of a new option.

Consequently, this ‘new option’ may have a much higher grant price and may not have been held for sufficient time to qualify for capital gains tax breaks, for example.

In the worst-case scenario, options could be treated as unapproved (non-qualifying) options, which would give rise to income tax (and potentially National Insurance Contributions) on exercise, based on the market value at that time.

In a business sale scenario, this could convert what was intended to be a highly tax-efficient EMI share option into a non-qualifying option, triggering sizeable tax bills, based on the ultimate sale price of the business. Clearly, something to be avoided.

Adapting to these changes

It is crucial to understand that once discretion is exercised in violation of HMRC’s guidance, it will be too late to avoid the unexpected tax liability that may arise.

We recommend that professional advice is sought before exercising any discretion permitted under your EMI scheme.

Our team are happy to review EMI documents and advise you of any risk areas and possible solutions, no matter who prepared them – whether it be the firm’s lawyers, another accountant or a share scheme specialist firm.

We would suggest conducting a comprehensive review of the terms of your company’s EMI scheme. The objective is to determine if any discretion within the scheme breaches HMRC’s new guidance or has the potential to do so.

It would be easy to underestimate the significance of this new guidance, potentially only becoming aware of the implications before a company sale, at which point it may already be too late to take corrective action.

If you need assistance with the impact of this new guidance or would like us to review your existing EMI documentation, please speak to our experienced tax team.

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