As Brexit negotiations become ever more complex advisers to private companies looking to incentivise their employees with share options have been scratching their heads over a recent HMRC announcement.
On 4 April 2018 HMRC announced that an EU dispensation from State Aid Rules given in July 2009 was to expire on 6 April 2018 (see our previous blog on this subject). Companies and their advisers were warned that they might want to defer the grant of tax-advantaged Enterprise Management Incentive (EMI) options until the position was clarified.
It may be some time before the EU grants a further dispensation so what should companies do in the meantime? In this article we argue that companies could almost certainly ignore the HMRC advice!
EU State Aid Rules
EU State Aid applies where a Member State grants assistance to an organisation which distorts or threatens to distort competition and affects trade between Member States.
A tax break can amount to State Aid. So do EMI options fall foul of the Rules? The Government official who applied for a dispensation in 2007 must have thought they could apply. EMI options had been introduced by tax legislation in 2000 so there was already a gap of seven years before the Government considered that there might be a problem!
With Member States supporting their strategic industries with significant financial aid, how likely is it that this tax legislation delivering modest tax savings would be subject to enforcement action? The complexity (on which see below) would be significant even assuming the Commission were confident they could prove unlawful State Aid. So this seems unlikely to be a practical problem.
What tax benefits could be at risk?
The possible tax advantage to a company where an EMI option is granted, and continues to qualify on exercise, is that employer’s NIC at 13.8% on the option gain is not payable. In fact such NICs are only payable if the option shares are readily realisable on exercise: this would be the case if the company was in the process of being sold (or its shares are listed). Private company EMI options are often exercised before a sale when no NICs are payable.
Another possible tax benefit is that the option gain may count as an expense in computing the company’s corporation tax. But any such expense arises not from the EMI tax legislation but from the general accounting and tax rule that option gains are tax deductible. So it is hard to see any basis upon which that relief (if it is available) could count as State Aid.
So, assuming the EU Commission should decide to take enforcement action over illegal State Aid (which appears very improbable) the tax risk would be just employer’s NIC.
What about tax benefits for Employees?
Employees benefiting from tax-advantaged EMI options enjoy two key tax breaks. First they pay CGT not income tax on any option gain. Furthermore they can benefit from entrepreneur’s relief and pay tax at just 10% on the option gain.
A key point to note is that the State Aid rules affect organisations (or undertakings as EU law calls them). It does not apply to individuals.
So in the (very unlikely) event of EU tax enforcement action it seems that this would be against the employing company (as outlined above) not the employees who have enjoyed the tax benefits of the EMI option.
What happens on the sale of a company?
Any concerns over unlawful state aid on EMI options may be the subject of scrutiny when a company is sold.
Cautious advisers acting for the buyer will need to consider the advice they give on this subject. There will be five alternatives:-
- the buyer insists that employer’s NIC is paid if a retrospective EU dispensation has not been given;
- the buyer reduces the price by up to 13.8% of the NIC on the option gain and having pocketed the tax at risk awaits developments;
- the buyer and seller agree to share any risk of a claim of illegal State Aid;
- the sellers give an indemnity for the NICs to cover a future risk; or
- the seller discloses the risk and the buyer accepts it is a very low risk that need not concern them.
Our prediction is that sensible buyers will accept the very minimal risk and accept route 5)!
To wait or not to wait
Reflecting the above analysis the advice we are giving to owners is to press on with the grant of EMI options. This is a complex and uncertain area of the law and definitive advice is therefore difficult to give.
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