HMRC failure to renew State Aid approval puts EMI scheme in jeopardy 
by Kathy Hills

Two days before the deadline of April 7th 2018, HMRC announced* that the UK has failed to renew its EU State Aid approval for EMI schemes. This means that presently it is not possible to grant EMI options and raises a number of questions for existing options and the future of EMI schemes. The answers to these questions will depend on whether HMRC does eventually agree the State Aid question with the EU and the extent to which the approval has retrospective effect. In this article we look at the implications and what companies can do next.

Many SMEs in the life sciences sector, given their combination of high growth potential and cash constraints, have come to regard EMI options as an important part of their remuneration package. The core tax benefit from the EMI scheme is that if options are granted at an exercise price of no less than the market value at the date of grant, the increase in value above the exercise price is treated as capital gain and subject to capital gains tax. By contrast, with unapproved options, any increase in value is subject to income tax (and potentially also national insurance contributions). In addition, for capital gains tax purposes, employees do not need to satisfy the 5% shareholding criteria in order to benefit from Entrepreneurs Relief, and the period for which the option is held counts towards the 12 month qualifying period. With the Entrepreneurs Relief rate at 10% this is a significant tax advantage, particularly for life sciences companies which typically expect their share value to increase significantly and rapidly.

It probably came as a shock to many that the EMI scheme is treated as a State Aid, but when you consider the HMRC national statistics for 2017 which shows that the estimated income tax and NICs loss was £160m for the EMI scheme for the 2015-16 tax year alone and approximately £1.4bn since 2003, it is easier to understand. State Aid rules apply where benefits are provided to taxpayers selectively and as the EMI scheme is only available for SME companies within defined limits, State Aid approval is required for the EMI scheme.

The EMI scheme was originally introduced in 2000 without State Aid approval being sought. State Aid approval was given retrospectively in July 2009. Roll forward 9 years and history is repeating; only with the back-drop of Brexit looming, there is a lot more at play.

So where does this leave us?

Options Granted Before 7th April

HMRC have said in their statement issued on 4th April that they consider that all options granted prior to 7th April will continue to qualify for EMI tax relief. Their view is that State Aid approval applies only to the grant of the option. However, it appears from the original approval notification that the reason for the approval being given to 6 April 2018 was to allow for the approval to be valid throughout the 10 year period during which options granted at this time could be exercised.

It is not clear to us therefore that options granted prior to 7th April will continue to benefit from EMI treatment going forwards if State Aid approval is not given retrospectively. That said, it seems to us that in this scenario if pre-7th April grants are called into question, the most likely position is that growth in value from 7th April will be subject to income tax on an exercise of options but growth in value from the date of grant to 7th April will continue to benefit from EMI treatment.

SMEs can also take comfort from HMRC’s statement discussed above as it appears unlikely that HMRC would pursue tax on growth in value pre-7 April 2018 in any event.

Options Granted on or after 7th April

Options granted since this date may not qualify for EMI treatment. Ultimately, this depends on whether State Aid approval (assuming it is given) is given retrospectively to 6th April.

Depending on the package agreed for the UK’s departure from the EU, State Aid considerations may fall away in less than a year’s time. HMRC have stated that they are making every effort to obtain State Aid approval as soon as possible. However, given a Brexit deadline of 29 March 2019, any approval may only be required on a short term basis and therefore it may not be on the top of the EU’s priority list.

The optimistic amongst us will look to the recent renewal of State Aid approval for Ireland’s Key Employee Engagement Programme and Sweden’s Employee Share Tax Regime, which are similar to the UK’s EMI scheme and remind ourselves that good news comes in threes…

What now?

Here are our thoughts on some of the questions that you are likely to be asking about EMI schemes during the suspension of the scheme.

Can we still grant options to employees?

Yes, but it is not clear whether these will ultimately qualify as EMI options. It is widely expected that State Aid approval will be granted and it is anticipated that if consent is given, this will be retrospective. If consent is not given retrospectively, the option would be an unapproved option. No tax arises on an unapproved option unless and until it is exercised. It is relatively straightforward to surrender an unapproved option and grant a new EMI option if approval is not given retrospectively so, if any companies need to grant options during this period of uncertainty, we don’t think it is necessary to hold off on doing so.

Will HMRC still agree valuations prior to the grant of options?

This remains to be seen, although we anticipate that HMRC will continue to respond to valuation requests. We would hope in the circumstances that HMRC would consider extending the period during which the valuation is binding from the current 60 days, subject to any change in fortunes of the relevant SME during any longer timeframe.

Should Existing Options be Exercised?

Perhaps the first question to answer is whether the scheme allows options to be exercised. Whilst some schemes would allow an option to be exercised provided that any time/performance vesting conditions have been met, others require a trigger event such as a change of control before the option may be exercised.

For options which can be exercised, the aggregate exercise price will need to be funded by the option holder, as well as any tax arising on the exercise (if the exercise price was set at less than the market value of the shares on the date the option was granted).

Given the statement from HMRC that they consider options granted prior to 7th April will continue to qualify, employees may want to exercise exercisable options as a precaution where an employee can afford the costs of exercise, but this will not necessarily be essential to preserve the tax treatment.

Is it Still Possible to Notify the Grant of an EMI Option?

Again, in the circumstances it is not clear if a notification of grant of EMI options would continue to be valid in respect of options granted on or after 7th April. Given that the timeline to notify is 92 days from the date of grant of the option, we would suggest that the notification of such options should be delayed as far as possible as State Aid approval may be given during this time which would make the position much clearer.

We have approached HMRC’s employee share scheme technical team and will provide further updates when the answers to these questions become clearer.