Out-Law News

HMRC updates guidance on discretion clauses in EMI option agreements

Lynette Jacobs tells HRNews about an error made by HMRC in previous guidance on the use of discretion clauses in EMI Option agreements

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  • Transcript

    HMRC has updated its guidance on the use of discretion clauses in EMI option agreements. In their latest Employment Securities Bulletin they clarify how the use of discretion clauses affects Enterprise Management Incentive options and they correct a mistake which they highlight in case you’ve been affected by it.

    EMI Options are basically tax-friendly share option schemes, or share incentive plans, that companies can put in place to reward their employees with share options. They’re useful because they’re a good way of attracting and retaining staff, so especially important now. Many EMI option agreements and other plan documents contain discretion clauses which are designed to provide flexibility for the board of directors of a company to vary terms of an agreement after options have been granted.

    As the Revenue explains in the Bulletin, depending on the facts, an amendment to the terms of an EMI option agreement using these clauses might result in release and regrant of the option. This would mean that potential tax relief on gains accruing prior to the regrant is lost. It’s also possible that a change in the terms would result in a breach of the conditions for tax advantaged treatment.

    The guidance sets out the key principles that HMRC will use when determining whether the exercise of discretion will be allowable, and whether it will lead to a release and regrant of a new option. Flagging their earlier mistake they say: ‘We are aware of a small number of cases where HMRC may have provided advice on the use of discretion clauses which was not in line with the updated guidance. We apologise for this. We will attempt to contact customers who we believe received incorrect advice that may have resulted in tax deductions on the exercise of options.’

    So, let’s consider that. Lynette Jacobs is a share plans specialist and earlier she joined me by video-link from Manchester. I asked Lynette to explain the background to this, so, how EMI Options work:

    Lynette Jacobs: “So, within the rules, or the terms of a contract option agreement for EMI options, there will be set out occasions on which EMI options can be exercised. So, that means when the people can exercise their option, so pay any exercise price and acquire the shares. Quite often in EMI plans, there'll be so called ‘exit-only’ plans so that the individuals who have received the options only can actually get the shares as and when there's an exit, so the company is sold or the company IPOs, and then within that there may well be discretion. The discretion would be, for example, that when there is an exit event, so when the company is sold, the options can be exercised immediately on and following the sale. The may well be for the Remuneration Committee to say well, actually, you can  exercise it immediately before and conditional on that happening, and that's a useful discretion because, generally, the company that's buying your company wants to know that there'll be able to buy all the shares straightaway, they're not going to have to hang around for a month, or two months, until people exercise their options and they can purchase 100% of the company's share capital. So that's what discretion might be. A discretion might also be that if it's a certain type of leaver, so it might say that if you are you're a good leaver, if you are injured or if, unfortunately, you die, then there's discretion to include other people within that category. What happened was that it had generally been understood as to which occasions HMRC would say that exercise of discretion was fine and the option continues and it has its normal tax advantaged treatment, and occasions when it would say no, that's too much of a discretion that's been exercised and this option is going to lose its tax advantaged treatment, and in a series of cases, or requests to HMRC, to say, is this okay, is this exercise of discretion acceptable, some strange answers came back from HMRC and there was therefore correspondence with HMRC over a period of time, and lobbying to them from industry groups such as Share Plan Lawyers Group and ProShare, for them to explain what would, and what would not, be acceptable use of discretion so that the options with continue to have their tax advantaged status.”

    Joe Glavina: “So the Revenue has issued this warning in case customers have been adversely affected by the mistake. How would they know if they’d been affected by it?”

    Lynette Jacobs: “Yes, so during the period when the uncertainty was there, it would often be raised in due diligence when there's a sale of a company and the lawyers who are acting for the buyer, or the seller, will be asking the other side what's happened, and people would be wary of saying that an exercise of discretion by the Remuneration Committee might result in the options losing their tax advantaged status and there were a number of occasions and, I believe, that in the HMRC bulletin they refer to some ‘rogue inspectors’ or ‘rogue responses’ being given by some of their inspectors because in some cases the inspectors came back and said, no, this will result in these options no longer having their tax advantaged status and that's bad because the individuals then have to pay income tax and there is national Insurance contributions payable, both employer and employee, that would not otherwise have been expected and, in fact, quite often, under an EMI option, the option holders will have capital gains tax with business assets disposal relief, so they're paying 10% capital gains tax, and instead they were being asked to pay 45% income tax, possibly, and both full employer and employee NICs. If you're a company that had that situation, HMRC have said you should contact them and that's quite an unusual step for HMRC to take because it's obviously recognising that mistakes were made. Where we've come out with the guidance that the HMRC has set out, and they've updated their manual to give some helpful examples showing what is and what is not an acceptable use of discretion is basically what the case always was so that, as I said before, if it says the options are excisable on, or immediately following, the sale of a company, but the Remuneration Committee, or the board, has got discretion say, actually, you can exercise slightly before and conditional on it happening, that’s fine. Most of the cases to do with leavers, they're all fine, discretion is all fine. It's where new potential exercise opportunities are being introduced. So, for example, some plans have within them, so you can exercise generally on the sale of a company or a listing of a company, this is what happens if someone leaves along the way, but there's additional sort of overriding discretion that would allow the board or the Remuneration Committee to say, okay, just because this month has got an ‘r’ in it, you can exercise your option. If that is exercised, and they say right, things have gone differently from what we were expecting and actually now you can exercise, that is considered an unacceptable use of discretion and if the option were exercised in those circumstances, it wouldn't be treated as a tax advantaged option. Where we have clients that have that provision in, what we're explaining to them is that it's fine for that to be there, that itself is not going to be a disqualifying sort of effect on your EMI options. Just to know that if the Remuneration Committee exercised its discretion and allowed options to be exercised in that circumstance, then those options wouldn't have the tax qualified status but, that said, that allows the options to be exercised. It’s just to have sort of ‘eyes wide open’ as it were and to understand what the position would be.”

    The Revenue’s Bulletin highlighting this issue is Employment Related Securities Bulletin number 46. They say: ‘any customers who think they may have received incorrect advice should contact the Revenue’s share plans team and they give the email address for that. We have put a link to the bulletin in the transcript of this programme.


    - Link to Employment Related Securities Bulleting number 46

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