While option schemes are often set up in the expectation that they will be operated for an extended period, it is important to ensure that scheme documentation is regularly reviewed. This ensures that documents reflect any changes in law and practice since they were initially prepared. If not, there is a risk that the scheme may not operate as expected or, potentially, options may no longer qualify as EMI options. An example of this is a change in HMRC guidance on notifying “relevant restrictions” for EMI scheme purposes.
One of the requirements of the EMI scheme is that an option holder is notified of the restrictions attached to the shares that they may acquire under option. This must be notified at the time of the grant of the option. Previously HMRC has accepted that the relevant restrictions are adequately notified provided that the individual is given a copy of the company’s articles of association at the time that the options are granted. It was common practice to do this and simply cross-refer to the articles as a whole.
However, HMRC now states in its guidance that restrictions are not sufficiently notified unless they are specifically pointed out to the individual receiving options – ie you must specifically set out the restrictions in the option agreement (usually in a schedule). HMRC’s guidance is not binding and has not been tested in the courts so it remains to be seen whether they would decide that a failure to comply with this approach would result in a loss of EMI status (which would have significant adverse tax effects on employees).
It is good practice though to ensure that any new options comply with HMRC’s now preferred approach. Although we are not aware of HMRC taking specific action to challenge the EMI status of options which don’t comply with the guidance, we are aware of issues arising on corporate transactions where due diligence indicates the HMRC guidance has not been complied with. Buyers are likely, as a minimum, to require specific indemnities from sellers against the risk of tax liabilities arising from a loss of EMI status.
This particular example (though there have been others over the life of the EMI scheme) emphasises the importance of checking that pro-forma agreements are up to date with law and practice.