5 April 2008 - the taper relief clock ticks for the last time
Significant changes to the capital gains tax regime were announced by the Chancellor of the Exchequer, Alistair Darling, in his Pre-Budget Report last month. Such changes, if implemented, would result in a single rate of capital gains tax (CGT) of 18 per cent.
This briefing offers some guidance on the impact of the proposed CGT changes on Enterprise Management Incentive (EMI) options and the steps that could be taken in relation to such options before 6 April 2008 (when the new CGT regime is expected to come into effect).
Although there has been considerable pressure for the proposed changes to be scrapped or modified, the Government has, to date, suggested that it would only be prepared to consider “marginal” changes and has effectively ruled out a wholesale reversal of the proposals. However, because of this ongoing dialogue, it is not certain that the proposed changes will actually be implemented in their current form. If they are not, we will provide a further update.
An overview of the current position
From a tax perspective, the key features of EMI options are:
- no income tax or National Insurance contributions (NICs) are charged at the time of grant;
- no income tax or NICs are charged on any gain made on exercise provided certain qualifying conditions are fulfilled at the time of exercise and the option was not granted at a discount;
- the period of ownership for CGT taper relief on shares acquired on exercise of an EMI option starts on the date of grant of the option - not the date of exercise (as is the case for all other options); and
- provided the EMI option shares are “business assets” for CGT purposes (which is almost always the case), if an EMI option is exercised and the shares are immediately sold:
- between one and two years after grant, taper relief will reduce the taxable gain by 50 per cent - i.e. an effective tax rate of 20 per cent for a higher rate taxpayer; or
- two years or more after grant, taper relief will reduce the taxable gain by 75 per cent - i.e. an effective tax rate of 10 per cent for a higher rate taxpayer.
The changing CGT landscape
From 6 April 2008:
- the income tax and NICs treatment will be unchanged (as outlined above);
- taper relief will no longer apply, irrespective of when the EMI options were granted; and
- the CGT rate on any disposal, including of EMI option shares, will be 18 per cent.
The CGT annual exemption (currently £9,200) will still be available along with traditional techniques for further reducing CGT liabilities (such as transferring shares to a spouse or civil partner to utilise his or her annual exemption).
What can EMI optionholders do?
The key question for EMI optionholders is whether they should try to exercise their EMI options and sell their option shares before 6 April 2008 in order to benefit from any taper relief already accrued.
For those who have already held their EMI options for at least 2 years and whose gains are too large to be covered by their CGT annual exemption, it would seem logical from a tax perspective for them to exercise their EMI options and sell their shares before 6 April 2008. This is because such a sale is likely to be subject to CGT at a maximum rate of 10 per cent (for a higher rate taxpayer) - as opposed to 18 per cent from 6 April 2008.
However, such EMI optionholders will need to compare the risk of losing 8 per cent of current value with losing 82 per cent of possible future share growth.
Potential barriers to exercise and sale
Many EMI optionholders may not be permitted to exercise their EMI options before 6 April 2008 because of the terms and conditions of their options. Taking the approach of simply amending these terms and conditions so as to accelerate the exercise of options will almost certainly be treated by HM Revenue & Customs as the grant of a new option - which would have adverse income tax and NIC consequences.
Share dealing rules in quoted companies will have the effect of preventing the exercise of EMI options and the sale of option shares at certain times. In unquoted companies there may be no arrangements in place for optionholders to sell their option shares.
Finally, as mentioned, it is not certain that the proposed CGT changes will be implemented. So, if shares are sold before 6 April 2008 and the proposed changes are not then implemented, such shares will have been sold for no tax advantage and the prospect of gaining from share price growth will have been lost. Indeed, many employees may simply wish to remain shareholders for non-tax reasons, including the opportunity to benefit from future dividend payments.
EMI options after 5 April 2008
EMI options will continue to enjoy significant advantages over options granted under HM Revenue & Customs approved company share option plans (CSOPs). For example, they have a significantly higher individual limit (£100,000 versus £30,000), can have more flexible terms and are easier to establish and administer.
Going forward, EMI optionholders who exercise their options before 6 April 2008 may expect to be granted further EMI options shortly thereafter. However, once an employee has been granted EMI, or EMI and CSOP, options up to the £100,000 individual limit, that employee must wait until 3 years after the last of these options was granted before he can be granted any more EMI qualifying options, even if he has exercised some of the options during that 3 year period.
Consider, for example, an employee who was granted EMI options up to the £100,000 limit on 1 April 2006, who then exercises his option and sells his option shares (business assets) on 2 April 2008. This employee would benefit from full business asset taper relief and therefore be subject to CGT at 10 per cent (as the sale took place more than two years after grant and before 6 April 2008). However, this employee could not be granted another EMI option (over any value of shares) until 2 April 2009. This would not be the case if the employee had been granted EMI options over shares of any value below the £100,000 limit (even £99,999).
You may like to talk to us in more detail about the impact of the proposed CGT changes on EMI options or more generally. As one of the main drivers to the establishment of EMI option arrangements is to encourage employee share ownership, many companies have, in the past, been keen that employees do not simply sell their option shares at the earliest opportunity. Making employees aware of the alternatives is therefore of key importance.
Our team of dedicated employee benefits lawyers and our wealth of experience can help your company get the most out of its share incentive arrangements.