HMRC’s Employment Related Securities Bulletin 57 (published 14 October 2024) provides much needed clarification on applying the EMI (Enterprise Management Incentive) independence test.

The EMI independence test

EMI options offer significant tax advantages to employees and employers compared with non-EMI options.

Among the many EMI qualifying conditions, is the need for the EMI options to be over shares in an independent company.

The independence test is failed if the company is a subsidiary of, or otherwise under control of, another company. Connected parties must also be considered when assessing if a company controls the prospective EMI company.

Additionally, the independence test is failed if there are ‘arrangements in existence’, whereby the prospective EMI company could become controlled by another company.

New HMRC guidance

The new HMRC guidance clarifies some common structures that can lead to uncertainty in applying these independence tests.

What constitutes an ‘arrangement’?

HMRC has published guidance stating that any of the following scenarios could be considered an ‘arrangement’ to be controlled by another company:

• Deadlock provisions that could give another company the deciding vote.

• Provisions which allow the appointment of a company investor representative director to the board where the decisions of that representative director are deemed as made regardless of votes cast.

• Swamping rights – where a company investor (or group of company investors) obtains control of the board in the event of underperformance by the company.

• When a company investor representative director is appointed chair at a board meeting with a casting vote.

Distress provisions

HMRC has clarified that genuine distress provisions, that allow a corporate investor to gain control to rescue the company from failure, should not constitute arrangements. The existence of such provisions with the company’s Articles of Association or in a shareholder agreement shouldn’t cause the independence test to be failed. Examples of acceptable distress provisions include the following:

• A company failing to redeem any loan notes.

• A company breaching banking covenants.

• A proposed liquidation (other than a voluntary liquidation) of a company.

The guidance confirms that this treatment only applies to genuine distress provisions and not wider provisions designed to obfuscate control. The following provisions are examples where the EMI independence test would likely be failed:

• Where an investor can act ‘in their reasonable opinion’ if certain business performance measures have not been met.

• Where investors can hire or fire directors under certain circumstances where the company breaches certain financial covenants, such as not meeting profitability targets.

• Where the company breaches certain financial covenants, such as not meeting profitability targets.

• Where a corporate investor could get the majority of voting rights if a future event occurs that is not linked to distress.

Companies close to a sale

Companies in talks to be sold to a corporate buyer can also fail the independence test if there are ‘arrangements’ in place.

HMRC has clarified that any mutual understanding between the company and a potential buyer for the company to be sold would cause the independence test to be failed, even if no legally binding documents have been signed.

A mere offer letter generally would not be considered an arrangement for sale, until there is a mutual understanding between the parties that the parties will proceed with the deal.

Key takeaways

Whilst it can still be possible to grant EMI options close to a sale of the business or after it has received investment, the position should be reviewed in detail to confirm that the EMI conditions are met.

Ideally, EMI options should be granted in good time before a sale process, as granting when close to sale has extra complexity from an EMI qualification and a share valuation perspective. Where possible, key staff to incentivise should be identified early on and granted EMI options as early as practicable.

When receiving institutional investment, the distress provisions that potentially give the investor control should be carefully reviewed to ensure they don’t preclude granting EMI options.

Should you have any queries, please contact David Bareham, Share Schemes Director.