.png)
.png)
A Ltd is a trading company which is 100% owned by B Ltd which is a holding company. B Ltd, in turn, is owned 10% each by individuals Y and Z and 80% by C Ltd, which is a trading company. C Ltd is owned 25% each by three individuals V, W and X and 25% by JerseyCo.
A Ltd has a key employee which the company wants to retain and, as an incentive for her to remain with the company, the company wants to give her a shareholding which increases in value as the company grows.
A Ltd is a trading company which is 100% owned by B Ltd which is a holding company. B Ltd, in turn, is owned 10% each by individuals Y and Z and 80% by C Ltd, which is a trading company. C Ltd is owned 25% each by three individuals V, W and X and 25% by JerseyCo.
A Ltd has a key employee which the company wants to retain and, as an incentive for her to remain with the company, the company wants to give her a shareholding which increases in value as the company grows.
The most tax-efficient method seems to be by granting an enterprise management incentive (EMI) option, but the group structure as it stands does not allow this to be granted in A Ltd. C Ltd has various other subsidiaries and therefore an option cannot be granted in this company.
Is there any way in which the group structure can be tax efficiently unravelled so that the option can be granted in A Ltd?
Query T16,618 — Hope.
Reply by 'Thicket'
To enjoy the tax advantages conferred by the enterprise management incentives scheme, an option must be a 'qualifying option'. FA 2003, Sch 13 gives the technical details. The requirement which is causing a problem for Hope is that the option must be over shares in a company that is a qualifying company. There are three tests: independence, gross assets, and trading activities. To pass the independence test the company must be neither:
- a 51% subsidiary of another company (i.e. have more than 50% of its share capital owned by another company), nor
- under the control of another company (or such a company and persons connected with it) without being a 51% subsidiary.
As matters stand, an employee can not be issued with shares in A Ltd, his employer, as A Ltd is under the control of C Ltd (with B Ltd as an intermediary holding company). We are told that C Ltd is a trading company, and that it has other subsidiaries. Hope indicates that options over shares in C Ltd can not be issued under the EMI scheme, but we are not told why this is the case.
There seem to be two alternatives available. Either further explore the possibility of issuing options in the parent, C Ltd, or unravel the group so that A Ltd and C Ltd are held by the ultimate shareholders directly, rather than through a group structure. The second option is likely to be the more expensive and time consuming, and so it is worth exploring the first option thoroughly. Hope should appreciate that the requirement to be an eligible employee can be met by being an employee of a subsidiary company of the company issuing the option if the subsidiary is a qualifying subsidiary. This would seem to be the met in this case. The gross assets test is met if the aggregate value of the group assets does not exceed £30 million, according to Statement of Practice 2/2000 this is generally taken as the book value of assets shown on the balance sheet. The trading activities test is met if the business of the group companies taken together and regarded as one business does not consist wholly or to a substantial degree in the carrying on of non-qualifying activities and at least one company qualifies as a trading company.
It should be possible to devise terms for the shares under option to ensure that their value reflects the value of A Ltd. The only requirement is for the shares under option, i.e. C Ltd in this case, to be ordinary shares, i.e. with no right to a fixed rate of dividend. Within this restraint, it should be possible to design the articles of association for a new class of share so that the return on disposal is determined by the value of the ordinary shares in A Ltd, (and dividends likewise). In this way, the shares would shadow the return on A Ltd, and should achieve the required commercial purpose.
If, ultimately, it is decided that the group needs to be restructured, then the provisions in TA 1988, ss 213 to 218 cover the tax efficient demerger of two or more trading companies. Note that advance clearance will be needed under s 215 and s 707. It will be necessary to demonstrate that no tax avoidance motive is present and that there are bona fide commercial reasons involved. If the statutory demerger provisions can not be met, then the demerger by liquidation route will need to be considered. Peter Rayney describes this in his article 'Breaking up is hard to do', Taxation, 27 May 2004, page 217).
As a casual observer, restructuring the group, purely in order to be able to issue share options would seem to be a fairly extreme measure. However, if there are other reasons present, a demerger may be advantageous, and the ability to issue of enterprise management incentives options may well be a beneficial side effect. A common reason for the increasing popularity of demergers is to separate out a company qualifying for business asset taper relief from a mixed group of companies with tainted taper history. Substantial shareholder relief has also made demergers easier to achieve tax efficiently. — Thicket
Reply by 'Taxpartner'
This is one of those situations where the tax tail must not be allowed to wag the dog. While EMI share incentives are attractive, the prospect of obtaining them must not be allowed to dictate the way that the group is run. However, it appears that it should be possible to arrange matters so that an appropriate share option is available.
The group structure is complex. The obvious solution would be to dismantle it, but there may be very good commercial reasons why it should be maintained. However, if there are not then the ultimate aim would seem to be:
- the elimination of B Ltd;
- direct holding of A Ltd shares, 10% for each of Y and Z, and 20% for each of V, W, X and JerseyCo;
- C Ltd remaining with its existing shareholding, but with no stake in A Ltd.
The demerger provisions are set out in TA 1988, ss 213 to 218. They are intended to apply to the demerger of 75% subsidiaries, a test which is met both by B Ltd's ownership of A Ltd and C Ltd's ownership of B Ltd. Detailed guidance is given in Tolley's Corporation Tax 2004-05, paragraphs 29.34-29.57, but this should be a fairly straightforward exercise, and advance clearance can be obtained. EMI options could then be granted in A Ltd. It should be noted that A Ltd and C Ltd will still be associated companies, since they are both under the control of a 'perm any three from four' of V, W, X and JerseyCo.
If the group structure is there for a purpose, it seems that Hope has given up too easily on granting the EMI option in C Ltd. The stated aim is to give the employee 'a shareholding which increases in value as [A Ltd] grows'. There is no reason why this cannot be achieved by putting appropriate performance terms into the option agreement. Virtually the only requirement in ITEPA 2003, Sch 5 relating to the performance conditions is that they must be agreed in writing.
The number of shares over which the employee is given an option can therefore be fixed by a formula. This can have a starting figure of (for example) 1,000 shares in C Ltd with an option price of £1. The formula then provides that at exercise date this is multiplied by a figure to be determined by calculating what percentage of C Ltd's value is represented by the A Ltd holding at the end of the option, divided by the percentage it represented at the start. So if the A Ltd shareholding represented 50% of C Ltd's value at the grant of the option, but has increased to 75% by the date of exercise, the employee will be able to buy 1,500 shares at £1 rather than 1,000. This should give the incentive that Hope is looking for.
