EMI independence test – new HMRC guidance
What is the EMI independence test?
In order to qualify for the tax advantaged Enterprise Management Incentive scheme (EMI), a company must be “independent”. Broadly speaking, this means the company must not be under the control of another company. If the company does not meet or ceases to meet this “independence test”, it will not qualify for EMI. In addition, existing EMI options will be disqualified. A company can cease to meet the independence test simply by having “arrangements” in place that may lead to its coming under the control of another company.
It’s sometimes necessary to investigate the detail if you want to be sure about a company’s independence for EMI. This might including taking into account HM Revenue & Customs (HMRC) guidance.
Recent HMRC update
As telegraphed in ERS Bulletin 57, HMRC have recently updated their guidance set out in the Employment Tax Advantaged Share Schemes User Manual (ETASSUM)).
The update relates particularly to
- corporate structures that include a limited partnership or a limited liability partnership; and
- “arrangements” that may lead to an EMI company ceasing to meet the independence test.
Guidance on partnerships and LLPs
In ETASSUM 52030, HMRC has confirmed that HMRC does not treat LLPs as companies for the purposes of the EMI legislation. If an LLP controls an EMI company then this would not prevent the EMI company from satisfying the independence requirement, provided that the LLP does not have a corporate member.
However, an EMI company controlled by a partnership (of any kind) with any one of the partners being a corporate member will fail the independence requirement.
Guidance on arrangements leading to loss of independence
A new page in HMRC’s manual, ETASSUM52031, can effectively be divided into two sections.
The first section concerns a “sale” scenario. Here HMRC note that a non-binding agreement can potentially be treated as an “arrangement”. This type of non-binding agreement may include Heads of Terms, Letter of Intent etc. However an offer letter alone won’t constitute an “arrangement” until such time as all parties have reached a “mutual understanding”. That means that everyone (including the buyer) has agreed on the way forward, and they all expect that the sale will proceed largely on the terms set out in the offer letter.
The second section concerns distress provisions. These provisions are usually contained in an investment agreement. They set out situations when a corporate investor could take control of a company to rescue it from failure.
HMRC are of the view that the existence of certain distress provisions is not sufficient to constitute unacceptable “arrangements”. Examples of such distress situations might include:
- a company failing to redeem loan notes;
- a company breaching banking covenants; and
- a proposed liquidation (not including a voluntary liquidation) of the company in question.
However, any contrived or artificial arrangements will not be a distress provision. An example might be breaching an agreement because business performance was not as expected. A provision like this is really just offering protection to the investor. HMRC would likely consider such a provision as constituting “arrangements” that breach the independence requirement.
The new page concludes with four examples of where this would be the case. The named examples (not an exhaustive list) include:
- where an investor can act “in their reasonable opinion” if certain business performance measures have not been met;
- where investors can hire or fire directors under certain circumstances where the company breaches certain financial covenants, eg not meeting profitability targets;
- where the company breaches certain financial covenants such as not meeting profitability targets; and
- where a corporate investor could get the majority of voting rights if a future event occurs that is not linked to distress.
RM2 comment
The guidance is helpful and will undoubtedly reduce the number of queries that HMRC receives relating to the tricky area of “arrangements”. However, the examples provided are far from exhaustive. It will be important to pay close attention to the wording of, in particular, investment agreements to make sure that no unacceptable provisions lurk in such agreements.
Checking that a company qualifies, and continues to qualify, for EMI is not always straightforward. If you are in doubt you should take professional advice. Failure to do so may result in loss of tax advantages for the company and employees. It may also create difficulties on a sale of the business, including onerous due diligence investigations and potential price chipping.
If you are unsure about whether your company qualifies for EMI or if you are considering arrangements that may result in the company ceasing to meet the EMI test, please contact us on enquiries@rm2.co.uk to discuss.
