NEWS
HMRC’s recently published guidelines on the meaning of “arrangements” for EMI independence test purposes.
October 18, 2024
On 14 October 2024, HMRC published its Employment Related Securities Bulletin 57 (October 2024). This bulletin covers guidance on:
- the interpretation of “arrangements” for EMI independence test purposes
- the application of the ‘deeming provision’ to employment related securities and employment related securities options, following the Vermillion case; and
- processing of employment related securities.
This bulletin can be accessed from Employment Related Securities Bulletin 56.
Guidance on “arrangements” for EMI independence test purposes
For a company to be eligible to grant EMI options, one of the requirements is that the company should satisfy the ‘independence test’. In addition to the company not being a subsidiary of another company or not being under the control of another company (together with persons connected with that company), there should also not be any “arrangements in existence by virtue of which the company could become such a subsidiary or fall under such control”.
While the word “arrangements” has been defined in the legislation to include any scheme, arrangement or understanding, legally enforceable or otherwise, the scope of what constitutes an “arrangement” has not been specified in the legislation.
In the HMRC manuals at ETASSUM52031, HMRC has added a new helpful guidance, a summary of which is as follows:
What constitutes an arrangement?
The following potentially constitute arrangements:
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- a company having the deciding vote in a deadlock
- provisions that allow decisions of a company investor director to prevail irrespective of the votes cast in the meeting
- swamping rights of a company investor to obtain control in the event of underperformance of the company
- a company investor director having the casting vote in board meetings
Mutual understanding regarding a sale
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- at the point when there is a mutual understanding between the parties, including the potential purchaser, that all parties will work in a certain way (and that is expected to occur) the independence test will not be met
- non-binding agreements such as heads of terms, letters of intent etc. in relation to negotiations for the sale of a company would be strong evidence that an arrangement is in place; however, the mere existence of an offer letter from a prospective purchaser should not be regarded as an arrangement, unless the parties work in a way which would lead to a sale in accordance with the terms of the offer letter
- a requirement for approval from an external body (which is outside the control of the parties) would not constitute an arrangement, until the approval is received
Distress provisions
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- in HMRC’s view, provisions where a corporate investor could gain control in a genuine distress situation should not be regarded as an arrangement; distress situations may include, failure to redeem loan notes, breach of banking covenants or liquidation (other than a voluntary liquidation)
- provisions which are contrived or artificial to give control to a company investor in the future could be regarded as an arrangement; for example, where an investor can take control if in their reasonable opinion the performance targets have not been met or where the company has the power to hire or fire directors where a company has not met its performance targets, etc.
Guidance on the application of the ‘deeming provisions’
On 25 October 2023, the Supreme Court published its decision in HMRC v Vermilion Holdings Limited [2023] UKSC 37 providing clarity on what constitutes ‘employment related’ securities (ERS) options (and accordingly, ‘employment related’ securities) and the scope of the deeming provisions, for the purposes of the ERS legislation. Please see Supreme Court’s decision in HMRC v Vermilion Holdings Limited for a summary of the case.
The facts in brief, are that a consultant, i.e., a non-employee, through his nominee company, had received a share option from Vermilion Holdings Limited to whom the consultant was providing his services. Vermilion fell into financial difficulties and as part of the rescue package, the consultant became the executive chairman and the share option was cancelled in lieu of the grant of a new share option being granted over a smaller number of shares.
The question for the court was whether the new share option was an ERS option because it was granted by the employer (after the individual’s appointment as the executive chairman) or whether deeming provisions in the legislation applied to the new share option so that it may be regarded as non-employment related, because the original share option was not ERS (as the individual was a consultant when his nominee company received the share option)?
The Supreme Court judgment prescribed a ‘bright line’ test to first ask ‘who’ has provided the right or opportunity to acquire securities (or securities option) to the employee. If the right or opportunity to acquire the shares and securities (or securities option) has been made available by an employer or a person connected with the employer, such shares and securities, or options over them, automatically become ERS (unless certain legislative exceptions apply). There is no need to analyse the causation i.e. ‘why’ has the securities (or securities option) been provided.
If, however, it is not the employer who has provided the right or opportunity to acquire securities (or securities option), then it is necessary to ask ‘why’ was the right or opportunity to acquire securities (or securities option) provided to that person.
The scope of the deeming provisions was clarified by the Supreme Court and new guidance can be found in the HMRC manuals at ERSM20215, essentially incorporating the Supreme Court’s decision:
- the first question to ask is who conferred the ERS; if the right or opportunity to acquire a securities option is made available by a person’s employer, or a person connected with a person’s employer, then it is an ERS option, in that case, no further reasoning need to be considered
- where a company makes a rights issue or issues warrants to its shareholders and a shareholder is an employee of the Company, the shares and warrants are ERS and accordingly the ERs reporting requirements will apply in respect of the acquisition of the new shares and warrants
Processing of ERS
- recent changes to improve the information about ERS has been published to provide guidance about share schemes and the process for registration and reporting
- copies of EMI notifications and ERS returns should be saved as evidence, before their submission on-line
- if a share scheme is registered in error or is no longer operating, such a scheme should be ceased
- all ERS schemes must be linked to a live employer PAYE Scheme; if the PAYE scheme is closed the ERS scheme should be closed as well
While the guidance in the manuals provides a welcome clarification of HMRC’s views, it is by no means exhaustive. Accordingly, the terms of shareholders’ agreement and other corporate documents (including any side or offer letters) should be carefully analysed, and proper advice taken, to determine the EMI status of the company and the fate of any existing EMI options granted.
For further information contact JD Ghosh jd.ghosh@mm-k.com, Stuart James stuart.james@mm-k.com or Paul Norris paul.norris@mm-k.com.
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