Restricted activities: EMI can see clearly now with advance assurance

This post is part of our Entrepreneurial team’s regular series of blogs.

Despite the name, legislation regarding the Enterprise Management Incentive (“EMI”) scheme, is relatively lightweight; if you are a genuine SME there are few real pinch points for qualification. However, the main stumbling block for companies is often the qualifying trading activity requirement.

HMRC have set out a list of activities that are deemed to be excluded and undertaking any of these activities could lead to the company being disqualified for the purpose of EMI. A number of these activities are relatively straightforward and self-explanatory; take property development, farming, market gardening, and the provision of legal or accountancy services for example. Unfortunately, participation in any of these activities makes your company closer to winning an Emmy than an EMI.

For a full list of excluded activities, see HMRC’s guidance.

However, there are a few of these activities that exist in a somewhat grey area that companies need to be aware of before undertaking.

Receiving royalties and license fees

For many software companies, the receipt of royalties or license fees is the key revenue stream in their business model. Importantly, this does not encompass subscription fees being generated using a Software as a Service (“SaaS”) model.

So, if my business is generating income through the receipt of royalties and license fees, I’m disqualified, right? Not necessarily.

HMRC understand that this exclusion will negatively impact the genuine start-up companies that the scheme is designed to help. As such, they have implemented an important ‘carve out’ from this exclusion.

Where the receipt of royalties and license fees are generated from the exploitation of an intangible asset, for which the greater part has been created by the company continuing its trade, the company will not be disqualified from EMI. This bit of HMRC magic allows start-up companies to develop their product from scratch and to receive royalties and license fees from it, all while still qualifying for EMI. After all, don’t all unicorns need a running start?

Leasing

Another disqualified activity is leasing. Where a company generates its income from leasing its assets, regardless of whether they developed it from scratch or not, they will be disqualified from EMI.

However, what constitutes leasing is another grey area. The main indicator of leasing is that the customer is free to use the asset for the purpose for which it is intended. The example provided by HMRC revolves around what may be constituted as car hire: using the contrast between hiring a taxi, as opposed to say, a chauffeur. Here we must determine which can be described as a service and which can be considered a facility. In the eyes of HMRC, taxi hire can be viewed as the provision of a service and be qualifying for EMI, whereas chauffeured car hire is not.

When considering whether your company is generating income from leasing and, therefore, disqualified from EMI, it is vital to understand whether you are providing the asset to the customer for use by the customer, or if you are using your asset to provide a service to the customer.

Advance Assurance

Fortunately, HMRC operate a non-statutory clearance service that allows companies to write to them and ask for assurance that they will qualify if eligibility is a concern. This allows you to gain HMRC’s opinion before you jump the gun and issue EMI options to employees like wanted posters for Billy the Kid.

Additionally, if your company is being purchased, advisors will often look for evidence that HMRC has provided Advance Assurance marking your company as EMI qualifying. This is normally part of their due diligence procedures and makes it important in order to quell potential purchaser’s fears.

Should you have any queries on EMI, please contact the team and we will be happy to offer our expertise.

Three interesting EIS elements to learn about

This post is part of our Entrepreneurial team’s regular series of blogs.

After being in corporation tax compliance for almost 5 years, I felt it was about time I gave my wings a little stretch…so here I am, a Senior Tax Associate in the entrepreneurial tax team at Chiene + Tait (C+T).

With the backdrop of a global pandemic, it was strange starting a new job. I returned my laptop from my previous job and that evening I received my new laptop from C+T.

During my first team meeting at C+T, there were many acronyms flying around and grappling with these was initially rather tricky; the pace here is fast and efficiency is important, so the many acronyms are a necessity.

I anticipated my new role would involve a steep learning curve and, I can now say after four weeks, it most definitely has lived up to that. At this meeting I was already being assigned client work which was really exciting. I was expecting my first week to mainly involve lots of health and safety training and suchlike but even though there was a lot of training on those areas, it was balanced by the client work I was involved in and the training I received on EMI and EIS.

In my first two weeks, I was already involved in EMI valuations, preparation for an EIS report and research for various ad-hoc advisory pieces of work. I had also attended R&D technical meetings with clients and have now started drafting one of those R&D reports.

After these couple of weeks, the acronyms started to fall out of my mouth and the jargon started to get a little easier to understand. However, it is important to always be on guard as new terminology still crops up. My depleting stash of sticky notes are proof of this.

Anyway, enough about me. Now to delve into some of the interesting insights I have learned from my EIS work so far – here are three which show how complicated the subject can be, and the benefits of learning about it.

The Single Company Test versus the Substantial Test

If a single company wants to enter into a joint venture with another party, it should first consider either setting up or acquiring a subsidiary company (i.e. hold at least 51% of the shares in another company) before it does so.

The reason this is important for EIS is because it determines whether the company will be required to meet either the single company test or the substantial test. The substantial test applies when the company is part of a group and it is less difficult to meet than the single company test.

One of the requirements of EIS is that a company/group must either carry out a trading activity or exist wholly for the purposes to carry out a trading activity. Under the single company test, the legislation only permits an insignificant amount of the company’s activities to involve non-qualifying activities. The substantial test is that the group’s activities should consist of no more than 20% of non-qualifying activities. Therefore, by comparison, the substantial test has more flexibility.

The holding of investments is an example of a non-qualifying activity, and an example of an investment would be holding less than 51% shares in a company (for example, a joint venture). It is more difficult to prove, under the single company test, that holding such an investment is insignificant to the company’s overall activities than it is to prove that it is less than 20% of the group’s overall activities. As such, a company should therefore consider being part of a group (for example, by setting up its own dormant subsidiary) before it decides to enter into a joint venture, as it will be easier for it to preserve its EIS qualifying status.

If the single company test or substantial test is breached, the company would lose its EIS qualifying status.

The Control Condition

Continuing on from the above scenario involving an EIS company with a joint venture, it is also important that the ‘Control’ test is considered here. The ‘Control’ test requires that EIS companies can only have qualifying subsidiaries. This means that the EIS company can only control companies where it holds at least 51% of the shares.

Joint ventures tend to not be qualifying subsidiaries for the purposes of EIS, as the company will not usually hold more than 50% of the shares in that company. Therefore, it is important that the EIS company (in its own right or with a connected person) does not have control over the joint venture, and care should therefore be taken when drawing up joint venture/ shareholder agreements to ensure that this is so. If it does have control, the joint venture would be a subsidiary but not a qualifying subsidiary for the purposes of EIS.

If this requirement is breached, the company would lose its EIS qualifying status.

What to watch out for when spending money raised through EIS

A company is required to use the money raised from EIS wholly for the purposes of the qualifying business activity. The qualifying business activity must be carried out either by the company issuing the EIS shares or by a 90% qualifying subsidiary. The money raised should be employed within 2 years of the share issue (or, if it is later, 2 years from when the company begins its trade).

The legislation states that employing anything more than an insignificant amount of the money raised through EIS on a purpose which is not for a qualifying business activity will result in that round of investment being disqualified from EIS. For example, spending EIS money on a <90% qualifying subsidiary. A failure to meet the requirement does not itself result in the company losing its EIS status. The legislation allows for an insignificant amount of money raised to be employed for other purposes but does not specify what is meant by ‘not significant’.

If an investment round is disqualified from EIS, this can have a devastating effect for the investors in that round. The investors would lose their EIS relief for that disqualified investment round; and because of the ‘independent investor’ requirement under EIS, the investor would no longer be able to participate in future EIS rounds. This is because the investor would now hold shares which do not qualify for S(EIS) relief. It is therefore critical that a company takes care when spending money raised from EIS.

 

I hope you enjoyed reading about a few of the interesting insights I have picked up in EIS so far, and that it’s a useful guide to the kind of things you learn when you delve deeper into the subject.

If you have any queries on EIS, contact our team and we’ll be happy to help.

EMI consultation: share your views on possible expansion

This post is part of our Entrepreneurial team’s regular series of blogs.

One of the somewhat unexpected outcomes of the Budget on 3 March was the announcement of a consultation into the Enterprise Management Incentive (“EMI”) scheme. The EMI scheme, as noted in previous blogs, is a key tool for high-growth companies in recruiting and retaining employees.

Although there were many calls from industry bodies and professionals for a consultation on the scope of the Enterprise Investment Scheme (“EIS”), the Chancellor chose instead to focus on EMI, seeking evidence on whether the scheme should be expanded and how it could be expanded to best support high-growth companies.

The consultation is open and is seeking evidence on the following points:

  • Whether the scheme currently meets it policy objective of helping companies to recruit and retain employees.
  • Whether the scheme is meeting its objective of helping SMEs grow and develop.
  • Evidence on which aspect of the scheme is most valuable in helping SMEs with their recruitment and retention objectives.

The ways in which the scheme could be expanded could result in an extension of the qualifying trade criteria regarding the type of trade undertaken by a company, or perhaps the limits relating to the value of options a company can issue or an individual can hold, or less likely, an extension of the tax advantages, for example in relation to Business Asset Disposal Relief. Currently the limit of Business Asset Disposal Relief is £1 million, in line with the reduction from £10 million to £1 million for all eligible capital gains. It appears from the consultation document that one of the key areas for potential expansion would be regarding the limits imposed.

Further, the document asks whether the other tax-advantaged share schemes offer sufficient support to high-growth companies where they no longer qualify for EMI. We have recently commented on the use of CSOP as an effective tool, however, whether this is of much use once the EMI limits have been breached is questionable. The flexibility of EMI certainly makes it the most advantageous scheme and many companies will go on to use a form of growth share scheme once the EMI limits are reached, in order to ensure the highest growth opportunity for employees.

We will, of course, be responding to the consultation and encourage businesses who have used the scheme to either respond directly with evidence or get in touch with us if they wish to feed into our response.

If you have any questions on the consultation or how to provide evidence, please contact me as I will be collating our response.

EMI for start-ups: no time like the present to start-up your scheme

This post is part of our Entrepreneurial team’s regular series of blogs.

With each passing year it seems that start-ups become ever more prevalent.

Although the economy has been disrupted by the Covid-19 pandemic, the technology industry has experienced considerable growth. Entrepreneurs are seeing the opportunities that remote working brings and are looking to take advantage of gaps in the market. With the technology sector not looking like it is going to slow down anytime soon, how can your start-up find the difference that will ensure that it succeeds against all of the competition?

Although there is not one ultimate answer to success, having the right team is crucial. In fact, not having the right team has been found to be one of the top reasons for failure among many start-ups.

This is why the Enterprise Management Incentive (“EMI”) option scheme is such a valuable tool for young, growing businesses. With a work environment that often requires substantial commitment and hours, but with limited funds to reward employees for their efforts, granting tax advantageous EMI options can be a way for companies to attract and keep that team that will lead them to success.

So, when is the best time to start thinking about granting EMI options? Arguably the sooner the better. EMI options are granted following a valuation of the company’s shares which is agreed with HMRC. With unapproved (e.g. non-EMI) share options, the employee is subject to income tax and national insurance contributions on the difference between the value of the shares when the option is exercised and the option exercise price they pay, but with EMI options there is no income tax and national insurance charge due on this gain (as long as the exercise price is equal to or higher than the pre-agreed market value) – i.e. the gain made between the dates the options are granted and exercised is free of income tax and NICs (but it will be subject to the, lower, capital gains tax  charge – see below).

There will be capital gains tax on the eventual sale of the shares obtained through the options, but if 2 years have passed between the date of the grant of the options and the disposal then the EMI option holders may, if they qualify, be able to claim Business Asset Disposal Relief (previously Entrepreneurs’ Relief), providing an effective tax rate on the gain of only 10% on the first £1m of gain per individual.

So, with your employees having the prospect of reaping these rewards further down the line, EMI options are a valuable tool for incentivising staff and driving growth in your company.

If you are a very new start-up and, therefore, pre-revenue and yet to raise external investment (other than perhaps from friends and family) there really is no time like the present for incentivising and rewarding your current employees or encouraging others to join your team. In these circumstances, this can lead to a very low valuation of the shares for the purpose of granting EMI options; possibly the nominal value of the shares (usually 0.01p depending on what your share capital is divided into).

EMI option schemes are also worth considering at a later stage after initial investment has already been raised. In many cases, a company might issue options every year as a recruitment and retention tool. EMI schemes are a cost-effective and tax-friendly way for SMEs to incentivise employees, where the value of the company is expected to increase dramatically as the company grows.

If you are a start-up and have already started thinking about the best ways to incentivise and build your team or if you are further along in the process and want to grow your company even further, EMI options should always be considered. If you would like to pursue the possibility of this, please contact us in the Entrepreneurial Tax team here at C+T and we would be very happy to help.

New blog: my time working in the Entrepreneurial Tax Team

Mid-way through my third year at university, summer internships seemed to be on everyone’s mind. Most people I knew were talking about the roles that they had applied for and how important internships were for putting you in a good starting position post-university. Doing an internship seemed like a great idea, it would provide me with an interesting way to fill my 3-month summer break, learn more about the working world and develop new skills. Having enjoyed the brief two weeks of work experience I had done with Chiene + Tait the previous summer, an internship with the entrepreneurial tax team seemed like the ideal opportunity.  I applied and was thrilled when I was offered an interview and even more thrilled when I was offered a six-week position with the firm.

Going from university to working at Chiene + Tait took some adjustment. I’m currently studying Economics and Modern History and I thought when I first joined the firm that studying these subjects would be vastly different to working in an accountancy firm. At university I only have around six contact hours a week  (I’m sure the English and international students must wonder what they’re paying for a lot of the time) and, although the lack of teaching time does mean a significant amount of independent study and long days spent in the library, it is often quite an unstructured working environment. Joining the firm this summer has given me an insight into what my working life could be like. I have also found that although some of the knowledge I have gained from university may not always be useful (or who knows maybe one day that modern history essay on the cultural impact of the miniskirt will come in handy), the skills I have gained often are.

‘So, what actually is entrepreneurial tax?’ A question I have been asked many times by my friends and family since starting my internship at Chiene + Tait this summer, and one that I struggled to fully answer at first. Over the past three weeks I have quickly learned what a job in entrepreneurial tax entails (although from writing this blog I’m beginning to realise that I may never learn how to spell entrepreneurial), and I have seen the great work that Chiene + Tait does for growing businesses. Throughout my time here I’ve been assigned interesting and engaging work to do with the various schemes available to companies and investors. From Enterprise Management Incentives (EMI) to Enterprise Investment Schemes (EIS) and Research & Development Tax Credits the variety of work I have been assigned has been challenging but also enjoyable. It has shown me just how many fascinating companies the firm deals with.  I’ve even attempted some Corporate Tax which I think I might be finally wrapping my head around. In just three weeks my knowledge of Entrepreneurial Tax and other types of tax has grown substantially, and I can now provide a more detailed answer when people ask me what entrepreneurial tax is.

The work and type of clients have been very interesting but above all, being made to feel part of such a friendly team has made the whole experience very enjoyable.