ETASSUM54310 - Enterprise Management Incentives (EMI): Requirements relating to options: Discretion: Key Principles

Paragraph 37, Schedule 5 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA)

The legislation in paragraph 37(2) Schedule 5, ITEPA provides the terms that an EMI option agreement must state. This includes the three fundamental terms of an option, which are discussed in ETASSUM54060:

  • The number of shares which may be acquired
  • The price at which shares may be acquired
  • When the option may be exercised and shares acquired

There is a distinction between the fundamental terms and other conditions, such as performance conditions, which affect the terms of an employee’s entitlement in accordance with paragraph 37(3) Schedule 5, ITEPA.

Key Principles

Amendments stemming from the use of a discretion clause must adhere to the requirements of the EMI provisions. Amendments to the fundamental terms of an option agreement would result in a release and re-grant of an option, unless the amendment is minor. In general, the following key principles will be used by HMRC when determining whether the exercise of discretion will be allowable or whether it will lead to a release and re-grant of a new option. More detail about the case law which underpins the key principles is in the section below.

These key principles are as follows:

  1. So long as it is sufficiently clear in what circumstances, and when, an option is capable of exercise from the outset, an exercise of discretion to accelerate the vesting or to vary or waive a performance-related condition is acceptable, provided that the effect of the exercise of discretion is not to bring forward the date on which the option would otherwise become exercisable.
  2. Consistent with the Burton Group decision, HMRC will not generally take issue with the varying or waiving post-grant, on a fair and reasonable basis and in appropriate circumstances, of performance-related conditions for the ‘vesting’ of an option.
  3. It is not acceptable for an option to become exercisable in circumstances where the board has complete discretion to choose the circumstances under which an option may be exercised. For example, discretion that allows for the option to be exercised at any time the board so wishes or where there are specified terms of exercise in the option agreement from the outset, but the board may allow exercise at any other time or in any other circumstances, would not be acceptable. Any use of discretion in this way would amount to the grant of a new right within the principles in Eurocopy and Reed International.
  4. Once an option has been granted, in line with Eurocopy and Reed International, it is not acceptable to amend the option agreement rules or use discretion to create a new right of exercise, introduce a discretion clause where none existed before or to change the date of exercise, unless the amendment does not involve an improvement to the rights of the option holder which is more than de minimis.

Relevant Case Law

A more detailed summary of the case law involving tax-advantaged share schemes can be found on the following pages:

ETASSUM47250: Burton Group
ETASSUM47260: Eurocopy
ETASSUM47270: Reed International

Whilst the cases relate to other types of tax-advantaged share schemes, the principles established are applicable to EMI schemes.

Burton Group concerned an amendment to performance conditions in an approved executive share option scheme.

The judgement by Vinelott J stated that the number of shares which an employee may acquire upon exercise of an option could be governed by conditions imposed or varied in good faith after the option was granted.

HMRC will generally not comment on amendments to performance conditions.

Both Eurocopy and Reed International considered amendments which affected when shares may be acquired upon exercise of an option.

In the Eurocopy judgement, Mervyn Davies J noted that a right to acquire is a right to acquire a specified number of shares at a specified price within a specified time span. If the time span is altered, the right is altered and it is no longer the same right.

In Reed International, it was noted that a very minor improvement to the rights of the option holder is not sufficient to cause the grant of a new option.

Burton Group provides greater scope for amendments to performance conditions than are allowed under the principles in Eurocopy and Reed International for amendments to fundamental terms.

Whilst the relevant case law considers contractual amendments rather than the operation of a discretion clause, the principles apply equally in both contexts.