Enterprise Management Incentives (EMI) share options continue to represent a powerful weapon in the armoury of small and medium-sized businesses when it comes to recruiting and retaining key employees.
Whilst the reduction of the lifetime limit on entrepreneurs’ relief qualifying gains (from £10 million to £1 million) introduced by the recent Spring Budget has the potential to curtail the overall tax advantages conferred on those making very large gains under EMI, the Budget also included an encouraging statement regarding the future of this type of incentive.
The government has indicated that it will be reviewing the EMI legislation to assess how effectively it meets its objective of enabling smaller companies to recruit and retain staff. It is hoped that this may precipitate a relaxation of certain of the current qualification criteria in a way which brings more companies within the ambit of EMI and allows the scheme to be used even more widely.
This article focusses on elements within the five EMI qualification headings which could be relaxed to make the incentive more accessible and attractive to a greater number of companies.
1. Independence test
EMI options can only be granted by “independent” companies. This generally means that the company whose shares are the subject of the options must not be a 51% subsidiary of another company or otherwise under the control of either (a) another company or (b) another company and any person connected with it. Additionally, there must be no arrangements in place as a result of which the EMI company could become a subsidiary or fall under such control.
In practice, the fact that the interests of connected persons are aggregated with corporate shareholdings under the “control” test can be a blocker to EMI. This is particularly acute where an individual controlling shareholder is (or a group of controlling persons are) connected with a corporate shareholder (no matter how small that corporate shareholder’s interest is).
Moreover, a strict interpretation of the “arrangements to control” test (as demonstrated by HMRC in recent years) has the potential to capture arrangements put in place in the context of venture capital or private equity transactions which may be considered reasonable measures to protect investment (such as step-in rights in the case of poor business performance).
In many cases the corporate shareholdings or arrangements are insignificant and remote and therefore have no substantive effect on how the EMI company is controlled. These aspects of the independence test could therefore be relaxed to make EMI more accessible.
2. Gross assets test
The gross assets of a company (or of its group if the company forms part of a group) must not exceed £30 million at the time of grant to qualify for EMI.
The calculation of gross assets for these purposes is not always straightforward (particularly in relation to a group where certain assets of group companies are included/excluded from account). Moreover, there is limited guidance on the inclusion of certain assets (such as intangible assets) within the calculation.
Not only could the current £30 million limit potentially be adjusted upwards but a simpler process (e.g. allowing the use of consolidated group figures included within the last audited accounts) could be introduced.
3. Trading activities
Since their introduction the avowed objective of EMI options has been to encourage risk taking and entrepreneurship. For that reason, companies involved in certain trades which are perceived to be “low risk” or which are involved in activities which are not perceived to be sufficiently entrepreneurial will not qualify to grant such options.
The current restrictions on trading activities could be relaxed to allow more companies to access EMI, in particular for technology and IP heavy businesses where royalties/licence fees are a significant part of their income.
4. Full-time employees
Only companies with fewer than 250 full-time equivalent employees (measured at the time of grant) can grant EMI options.
This limit could be adjusted upwards to allow more companies to access EMI.
5. Value of awards
There are limits on the value of the shares that can be the subject of EMI options which apply at both company and employee level.
At a company level, a £3 million overall limit applies to the value of shares (measured at the relevant grant dates and ignoring certain restrictions to which the shares are subject) that can be the subject of unexercised EMI options.
At an employee level, an employee may only hold unexercised EMI options over shares with a value up to £250,000 (again, measured at the relevant grant dates) at any one time. Additionally, an employee who has been granted EMI options over shares of £250,000 cannot be granted any further options for a period of three years.
These limits could be adjusted upwards to allow a greater number of employees to be granted EMI options and for more meaningful awards (from a pure quantum perspective) to be made. This could be the case for companies in specific sectors or of a specific size, resulting in something akin to a two-tier EMI structure.
The three-year rule mentioned above could also be removed/relaxed as its operation is arbitrary and often results in EMI options being granted over a maximum of £249,999.99 in order to stop it from coming into play.