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Tax Bite – EMI share valuations – recent developments

Tax Bite – EMI share valuations – recent developments

In addition to the considerable tax benefits of enterprise management incentive (EMI) options, the ability to agree with HMRC the market value of shares to be placed under EMI options is another really attractive feature of this type of share incentive.

Outside of EMI and CSOP options, it is generally not possible to seek HMRC’s agreement to a share valuation, whether on a pre- or post-transaction basis. When HMRC agrees a share valuation for EMI purposes, that agreement will be valid for EMI options granted within the following 90 days, assuming the valuation application disclosed all relevant information and nothing changes between the application being made and the actual option grant date that could impact the view of valuation. If an EMI option has an exercise price no lower than the market value agreed when the option was granted, there is no income tax on exercise of the option (assuming the option maintains EMI status) even if the shares are much more valuable when the option is exercised, e.g. on exit.

We handle a lot of EMI valuations (although we are not valuers, so on growth shares and other more complex valuations we may need to involve specialist valuers). This Tax Bite provides a quick round up of some tips and issues we have come across recently.

1. Update the Articles in advance if the options will be over a new share class – in the past, HMRC used to engage with valuation requests if you described the relevant share rights in enough detail. Recently however it has become clear that HMRC will refuse to engage unless the new share class rights have been enshrined in (formally adopted) new articles of association prior to the valuation application going in. Those articles need to be included with the valuation request.
2. Be clear on the maximum number of shares to be put under option – again in the past HMRC have generally responded on valuations where the overall maximum number of shares to be put under option is TBC, however we have seen recent correspondence indicating that HMRC may reject applications on this basis now.
3. Start-ups, e.g. with EIS funding – historically, on most occasions HMRC would accept that ordinary shares in loss-making start-ups with uncertain outlooks, that had taken on speculative investments in shares (but were burning through the investment cash), would have no more than nominal value. HMRC have now moved away from that position and appear to be approaching such valuations, even where the investment was under EIS / SEIS, on the basis that the most recent investment price is the starting point for market value, and that it is for the company and its advisers to convince HMRC that any discount to that price is appropriate when valuing an ordinary share for EMI purposes. HMRC do still seem to be routinely agreeing such discounts, but their stance has definitely toughened, and any discount would be lower than typically we would have expected.
4. Involvement of HMRC specialists and resulting delays – we are seeing more and more valuation applications being referred to HMRC specialists where they are not totally plain vanilla applications, and this can result in much longer overall turnaround times than in the past.
5. “Take it or leave it” – we have seen numerous recent examples where HMRC have said they will not engage in any further detail after pushing back on the initial valuation requested, on the basis that EMI valuation agreements are a voluntary service on the part of HMRC, and taxpayers are free to proceed on the basis of their own view of valuation if HMRC have disagreed with the proposal put forward. This is unfortunate as it leaves companies with the choice of proceeding on the basis of HMRC’s view of the valuation (which may be clearly higher than should reasonably have been expected) or proceeding with their own view, which for example a buyer would be concerned about if looking into the options on due diligence on a later transaction. Even when HMRC say this, however, it is still worth trying to engage and sometimes they will.
6. Growth shares (and variants) – HMRC have long been known to have issues with growth shares, and this has now clearly been taken up by their valuation team. This is relevant to “classic” growth shares and also ordinary shares that stand behind preference shares (or other shares with preferential rights). In the past, it was often possible to obtain agreement that a class of growth shares that, say, only participated in value above a “hurdle” that was set marginally higher than the view of the current total market value of the company, would have only a nominal initial market value. We would now expect HMRC to reject that view – we understand they will expect a more detailed assessment of value using a methodology such as expected future returns, i.e. based on projections and hoped-for increases in value, discounted for uncertainty and time. We are not able to prepare those kinds of specialist valuations, but do work with a number of valuation specialists who can assist.

We see a regrettably high number of issues with EMI options on transactions where something hasn’t been done correctly, be it deficient documents, failure to comply with notification or other administrative requirements, or issues with valuations. Sometimes the issues can be solved without too much difficulty, but not always. Whether you are working with clients looking to set up EMI schemes or other share incentives, or perhaps dealing with option issues in the context of a transaction, please feel free to get in contact for our help.