Monthly Tax Idea - May 2012

Entrepreneurs’ relief (‘ER’) is a valuable relief for individuals selling shares in companies or unincorporated businesses. Capital gains are taxed at only 10% on lifetime gains up to £10 million, compared with the normal capital gains tax rate for higher and additional rate taxpayers of 28%.  The relief is therefore worth up to £1.8 million per individual.

To qualify for ER on the sale of shares in a qualifying company, the individual must normally have held 5% or more of the ordinary shares for at least 12 months prior to the disposal, and work for the company. 

Significantly, the requirement for a 5% shareholding is being removed where the shares have been acquired through the exercise of Enterprise Management Incentives (‘EMI’) share options on or after 6 April 2012. 

EMI schemes will allow more people to access a 10% tax rate

EMI schemes are share option schemes and are a useful way of incentivising employees, based on the medium to long-term capital growth of their option shares.  The removal of the 5% shareholding requirement to qualify for ER means EMI schemes potentially allow many more people to benefit from ER.  This makes them a great way to incentivise key employees and encourage them to stay with your company. The good news doesn’t stop here either, because the maximum value of options which can be awarded to a given individual is also being increased - from £120,000 to £250,000 (up to an overall maximum of £3 million), once EU approval is given. Income tax and NICs are not payable on the grant of an EMI option, and as the employing company gets a tax deduction too, EMIs are tax efficient all round.

Existing shareholders with less than 5% shares

There are also opportunities to use the enhanced ER position of EMI options for employees of qualifying companies who have existing shareholdings of less than 5%.  By exchanging their shares for immediately exercisable EMI options, ER should apply on the ultimate disposal of those shares, subject to all relevant conditions being met.  This is the tax equivalent of alchemy where base metal becomes gold – turning a shareholding from non-qualifying to qualifying! 

The same philosophy applies if you want to make an award of shares of less than 5% of the company’s ordinary shares.  Instead of making an outright award of shares, grant EMI share options instead, so that ER will be available on the future disposal of those shares (again subject to all the normal requirements being met).

Exit based EMI schemes

Many EMI schemes only allow the options to be exercised immediately before a sale or a flotation.  This means that the option holders will still not be able to qualify for ER because they will not own the shares for at least 12 months before selling them.  A change in the scheme rules to allow early exercise could be considered here.  However, if that is not feasible, all is not necessarily lost.  There may still be other opportunities to secure ER for employees who will be staying on with the company.

Both entrepreneurs’ relief and EMI schemes have detailed conditions, so you must always take advice based on your specific circumstances.

If you would like more information, please contact Emma Wise.