Don’t give up on EMI schemes too quickly!

The issue

Enterprise Management Incentive (EMI) schemes provide a tax efficient way of incentivising key employees with share-based rewards.

Typically, an EMI scheme will involve issuing individuals with options over shares that can be exercised when certain vesting criteria are met, or ahead of a company sale. The options incentivise those individuals to contribute towards the growth of the business while also being tax efficient for both the individual and the employing company. In particular,  an employee will be incentivised to stay until a sale when they face the prospect of a windfall which will be taxed at capital gains tax rates.

There are a number of qualifying conditions for a company to issue options under an EMI scheme. The condition we are focusing on here is the requirement that the gross assets of the company (or group) do not exceed £30m – i.e. the “gross assets test”. Gross assets are defined as the assets on the balance sheet before the deduction of any liabilities (there is no netting off).

For groups of companies, you would be forgiven in thinking that a review of the parent company’s consolidated accounts would be enough to determine whether the group meets the gross assets test. However, this is not always the case as you will see below.

The legislation

For groups, the legislation defines the group’s gross assets as those from the standalone balance sheets of each of the members of the group, excluding intra-group rights and holdings in group companies. This will often produce a different result when compared to the gross assets within the consolidated accounts, where goodwill will often be included.

The question on whether goodwill is taken into account for the purposes of the gross assets test depends upon the circumstances in which the goodwill arose. If it arose as the result of the acquisition of a business (i.e. trade and assets), the amount paid for goodwill is included in the balance sheet of the acquiring company and will therefore be included in its gross assets. If the goodwill arose on the acquisition of another company (i.e. shares), then there will be no goodwill on the acquiring company’s balance sheet, as the cost of the investment will be reflected instead. However, goodwill will often be recognised in consolidated accounts and it is this goodwill that does not count towards gross assets for EMI purposes.  

Example

Goodwill Holdings Ltd, the parent company of a group, is looking to issue EMI options to several key employees. The company has acquired shares in a number of subsidiaries and its gross assets, as stated in the consolidated accounts, are as follows:

At first glance, it may seem that the company would not qualify for EMI purposes. However, under the legislation we should exclude the goodwill of £10m when adding up the gross assets of each of the individual group companies (and remember we do not count shareholdings of group companies within this), leaving gross assets of £23m. Consequently, the group should qualify for EMI purposes. 

WSM’s view

The take home message here is that a proper job needs to be done to ensure whether a group can qualify for EMI purposes. We have often seen very high value consolidated balance sheets and then concluded that EMI options are still viable. This also reminds me that there can be certain planning steps that can be undertaken if the gross assets test is initially failed. For example, certain cash rich companies may want to use cash to pay off creditors so that they reduce their gross assets to an acceptable level. They could also chase significant debtors and then use the cash to pay off creditors. As the title says, we should not give up on EMI schemes too quickly!