EMI options and board discretion: HMRC guidance

HM Revenue and Customs (‘HMRC’) published guidance on the inclusion and use of board discretion in Enterprise Management Incentive (‘EMI’) share option plans. If board discretion provisions are not carefully drafted, these may affect tax treatment of EMI options. Our Corporate & Commercial team summarises the key points which are of particular importance to our growth clients.

In the context of a share plan, the exercise of discretion usually involves the board of directors using their judgement to come to a decision. For instance, this may include deciding to treat a departing employee as a ‘good leaver’ or deciding to increase the number of vested shares on an exit (known as an ‘acceleration’).

To avoid adverse tax consequences, board discretion must be clearly set out when the option is granted. HMRC treats any amendment to an EMI option agreement or use of discretion to create a new right of exercise, introduce a new board discretion, or change the exercise date, as the grant of a new option – depending on the circumstances, this may lead to the loss of some or all EMI tax benefits unless any improvements to the employee’s rights are limited.

A decision by a company’s board to exercise discretion may result in the share option being treated as released and regranted. This may impact tax benefits that the EMI Scheme is designed to deliver.

EMI regulations set out three ‘fundamental’ terms which are set out in a written EMI option agreement (‘Terms’):

• the number of shares under option;
• the exercise price per share; and
• when the option may be exercised.

An exercise of a board discretion that results in an amendment to any of the Terms is likely to result in the option being treated as released and regranted and the tax benefits lost – unless the amendment has ‘minimal’ effect.

The following provides a brief overview of HMRC’s guidance.

• for ‘exit-only plans’ (such as an IPO, sale or other change of control), there may be a loss in tax benefits where there is a general board discretion i.e., the discretion is not tied to any particular event and there is a general ability for the directors to determine an option is exercisable at any time and under any circumstances that the board chooses;
• for ‘non-exit only’ plans, provided that the board’s discretion is not to bring forward the option exercise date determined at the outset and there are adequate provisions in place, if the board chooses to accelerate the extent to which an option may be exercised (i.e. its vesting) this should not affect the option’s tax treatment; or
• for ‘non-exit only plus performance condition’ plans, to vary or waive a performance condition should not affect the option’s tax treatment, provided there are adequate good leaver provisions set out from the outset and this is done in appropriate circumstances only.

HMRC will treat any amendment to an EMI option agreement or use of discretion to create a new right of exercise, introduce a new board discretion, or change the exercise date, as the grant of a new option (which, depending on the circumstances, could lead to the loss of some or all EMI tax advantages) unless any improvements to the employee’s rights are limited.

If there is uncertainty, professional advice should be sought when directors exercise a discretion in an EMI share option plan.