Towards the end of 2022 HMRC announced some important changes to its Guidance on the use of discretion in EMI share options schemes. Now that the smoke has cleared and share scheme professionals have had time to digest the full impact of these changes, we discuss what they mean to companies operating EMI schemes and what they need to do to keep on the right side of the new rules.
By way of background, discretion clauses are commonly used in EMI schemes in three scenarios:
- Good and bad leaver provisions, to allow the Board of directors’ flexibility in deciding how a leaver should be treated;
- ‘Exit only’ plans, to determine when an option can be exercised on a corporate event; and
- Performance and vesting conditions, to give the Board the ability to reflect changes in circumstances or a corporate event.
HMRC’s new updated Manuals now set out useful detailed guidance on the use of discretion in these circumstances and what HMRC will and will not allow. Helpfully, generally speaking, having an unacceptable discretion in the terms of an existing EMI will not invalidate the option, but exercising that discretion, say on an Exit or when a participant leaves, could well disqualify the option.
Dealing with leavers
Dealing with leavers first, this is where HMRC have been most helpful, confirming that the common practice of including Board discretion to allow good leaver treatment for someone who doesn’t fall squarely within a specific good lever category (e.g. redundancy/retirement/ill health) is acceptable.
Turning to Exit only plans, these are plans where the option is only exercisable on certain ‘specified events’, such as a sale of the company. These are quite common in small and high growth companies. HMRC makes clear that an option must have a clear right of exercise from the outset. As such, any provisions, which only allow exercise on such events at the discretion of the Board are unacceptable. Allowing exercise on an Exit/corporate event is however fine, and you are free to define such events as narrowly or widely as you wish, to suit the company’s particular circumstances. Allowing exercise on a specified event, but with a discretion to allow exercise in other circumstances would be unacceptable, but as mentioned above, would not of itself invalidate the option unless that discretion was used.
The other type of plan, more common in larger and/or more well-established companies, is where the option vests and becomes exercisable over a number of years, often dependent on meeting certain financial performance targets. This is the most complex area of the Guidance. It has been long established in case law that amending a ‘fundamental term’ of an option (such as bringing forward the earliest date of exercise) is treated as the grant of a new option (in effect, disqualifying the existing EMI option).
HMRC’s new Guidance states it does not change this position.
For example, having a discretion which allowed an option that vested and became exercisable over three years to vest and become exercisable over two years instead would be unacceptable. However, there are a couple of nuances to this.
Firstly, it is permitted to have a discretion to change the vesting/performance conditions as long as the earliest exercise date remains the same.
Secondly, relying on the ‘specified event’ provisions above, it is permissible, in addition to a provision allowing exercise following vesting, to have Board discretion to allow accelerated vesting and exercise on a ‘specified event’ such as an Exit (even to a greater extent than the performance conditions have been met), provided this discretion was in the plan from the start.
What should you do next?
We recommend that you ask your share schemes adviser to review the terms of your existing EMI plans to ensure that any discretionary terms they contain are compliant with HMRC’s latest Guidance and to advise on appropriate exercises of discretion going forward.
We’d be happy to review and advise on any existing plans, just call us on 020 3818 9420 or email email@example.com to arrange an initial discussion with one of the team.
Read more about EMI’s here.