INSURING EMI SHARE SCHEMES: TOO MANY OPTIONS?

Themis continues to see increased demand from brokers and clients in the UK for tax insurance solutions in respect of EMI Share Schemes.

The bulk of the enterprise management incentive (“EMI”) code is found in Schedule 5 to the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). This is a tax advantaged scheme simplifying compensation and retention of key personnel.  

An employee who has EMI options granted to them does not have to pay income tax or national insurance on exercise, where the exercise price is equal to the actual market value of the options. Where the onward sale price of the shares is greater than the exercise price, the employee pays capital gains tax on the difference. Not only does the employee get access to the lower rate of capital gains tax on exit, the rules for qualifying for the lower rate under the business asset disposal relief are relaxed in relation to EMI options.

A useful tool then. However, in practice EMI schemes are not always perfectly implemented, and given the strictness of the rules involved this is understandable. Where improperly implemented, EMI schemes can lose their tax advantaged status.

Tax insurance may be able to cut through issues arising in relation to EMI schemes, especially those risks that arise in relation to the legal interpretation of parts of the EMI rules. Some key themes we have seen include:

Cover sought - “Arrangements”‍

Cover that there is no breach of paragraph 9(3) is often sought. This part of the independence requirement requires that there are no “arrangements” in place by virtue of which the issuer could become a 51% subsidiary, or fall under the control, of another company.

Uncertainty arises because paragraph 58 of Schedule 5 of ITEPA defines “arrangements” very broadly as including “any scheme, agreement or understanding, whether it is legally enforceable or not”.

The appointment of corporate finance advisors and the signing of heads of terms are strong indicators that “arrangements” could be in place. On the other hand, where there is a genuine requirement for external approval of the sale which is beyond the parties’ control, “arrangements” will not exist until such approval has been given.

Cover sought – technical interpretation‍

Insurance can be provided in instances where a particular technical interpretation of the EMI code suggests securities may be outside the scope of the rules. Issues can arise where potential purchasers interpret option terms (and their compliance with the EMI code) differently to a seller; this difference in interpretation could lead them to consider EMI options as invalidly granted, for example where there is uncertainty as to when an option can be exercised. Parties in this instance may consider using tax insurance to protect the position, provided that adequate advice is sought and provided in relation to the point in question.

Cover sought – qualifying trade and UK PE‍

Some requirements of the EMI code (e.g. the issuer must have a qualifying trade and a UK PE) could fall under more “typical” tax insurance cover. Market participants will be familiar with the rules – and pitfalls – of establishing whether a “trade” is being performed and whether an entity has UK PE. The nuance here relates to whether there is a “qualifying trade”, defined at paragraph 15 as a trade which is carried on a commercial basis and with a view to realizing profits, and is not “excluded”. What is “excluded” is lengthy and out of scope for this article, but cover is unlikely to be provided to an issuer in an excluded trade.

If you would like to discuss any of the above risks or you believe that you have a risk that needs an underwriter with the ability to be a little bit more flexible in their approach, please do not hesitate to contact Pranav Subhedar or Byron Thomas.

Pranav Subhedar
pranav.subhedar@themisunderwriting.com

Byron Thomas
byron.thomas@themisunderwriting.com

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