Share option schemes serve as a useful tool for growing companies seeking to recruit and retain employees. Enterprise Management Imitative (EMI) options are particularly tax efficient for employees and companies that are eligible. One of the requirements of an EMI scheme is that an option holder is notified of the restrictions attached to the shares that they may acquire under option at the time the options are granted. However, what happens when a company wishes to alter or update the Articles of Association after options have already been granted?

Alterations can be so material that they amount to a “Disqualifying Event” which results in the loss of EMI tax reliefs. Alternatively, they may not amount to a Disqualifying Event but they may need to be notified to the option holder to ensure that the company is complying with its ongoing obligation to notify option holders of restrictions attached to the shares.

Disqualifying Events and the Income Tax (Earnings and Pensions Act) 2003

EMI legislation sets out certain Disqualifying Events that can trigger the loss of the EMI tax reliefs. Disqualifying Events can relate to the company or the employee. Unless the relevant option shares are exercised within 90 days of the Disqualifying Event, there is a risk that an increase in the market value of the option shares will become subject to income tax. Key Disqualifying Events are (but are not limited to) those set out below:

• The company no longer satisfies the independence test (i.e. falls under the control of another company, or becomes a 51% subsidiary);
• The company no longer meets the trading activities test;
• An employee stops being eligible because they cease to work for the company, or cease to meet the working time commitment;
• Any alteration to the option to increase to the market value of the underlying shares (such as the creation, variation or removal of a right relating to any shares in the company);
• Any non-qualifying alteration to the share capital of the company (e.g. a change to the proportion of sale proceeds on an exit); or
• Any non-qualifying conversion of shares from one class to another.

What do you do if you think there is a risk of a DE? Speak to the MBM Options Team

Alteration of the Articles can result in immaterial changes to the shares under option, which whilst not a Disqualifying Event, may amount to a change to the terms of the option that require notification to option holders. Such instances may include:

Restrictions that may affect the value of the shares. For example the shares becoming subject to new restrictions on transfer, altered drag-along or tag-along provisions or subject to forfeiture on leaving employment;

Requirements of share transfers such as the transferee entering into a deed of adherence to an existing shareholder agreement; or

• Changes which are disadvantageous the option holder.
• Understandably companies will not want to notify option holders of every small change to the Articles that might have an indirect impact on option shares and it can be a difficult judgement call whether to notify or not.
• It may also be difficult to decide if a change is so material that it risks being a Disqualifying Event that may need the blessing of HMRC.

Below are three key question to consider:

• Do the proposed changes to your Articles affect the rights of the shares under option?

If the answer here is “Yes” then a notification should be made. This may also be a Disqualifying Event. It may therefore be necessary to seek HMRC approval that the changes do not amount to a Disqualifying Event.

• Do the proposed changes result in minor and/or immaterial changes to the shares under option?

If the answer here is “Yes” then notification should be made to the option holders but HMRC approval is not required.

• What if the changes to my Articles have no direct effect on the shares under option but alter the procedures to be followed by shareholders or have some other indirect impact?

Notification may still be appropriate. For example changes to share transfer provisions in Articles are generally considered to merit notification to all option holders.

In all circumstances it is important that appropriate advice is sought.

Our view is that it is prudent to assume that most restrictions do have some impact and should be identified to option holders; even if such a clause is likely to be considered "trivial" for HMRC compliance purposes. Companies should be careful to consider changes proposed to their articles and whether such changes require approval from HMRC or simply notifying option holders.

Option schemes are a meaningful tool for companies and should be managed with care. If you require expert option scheme advice whether it is a query regarding the topic of this blog, or on option scheme more generally then contact the MBM Commercial options team at OptionsTeam@mbmcommercial.co.uk