One of the many conditions that must be satisfied by a company that wishes to grant share options to its employees under the Enterprise Management Incentive (EMI) arrangement or to issue shares that will obtain EIS or Seed EIS tax relief for an investor is that it must be ‘independent’ – it must not be a 51 per cent subsidiary nor under the control of any other company.
‘Control’ in this context means the power of one company to ensure that the affairs of another company whose shares are subject to EMI option or are EIS/SEIS shares are conducted in accordance with that company’s wishes. This may be through share ownership, voting power, or because of any powers conferred by Articles of Association or other document. (Sections 719 ITEPA 2003 and 995 ITA 2007).
The ‘independence requirement’ is an anti-avoidance measure to prevent the manipulation of profits which could lead to an artificial adjustment to the value of the shares. The EMI, EIS/SEIS legislation deals with three circumstances where a company would fail the ‘independence requirement’ if it is:
(a) a 51 per cent subsidiary of another
(b) under the control of another but is not a 51 per cent subsidiary
(c) under the control of another company and also another person connected with that other company.
Circumstance (c) is less easily understood than (a) and (b). Would a company that has 1,000 ordinary shares in issue of which all but one is owned by an individual with the remaining share owned by a company that is connected with that individual fail to satisfy the ‘independence rule’?
Consider the following example where both A Limited and B Limited are under the control of another company and also another person connected with that other company. Will each company fail the independence test?
55 per cent – Individual X
15 per cent – Individual Y
30 per cent – Z Limited (owned by X)
40 per cent – Individual R
15 per cent – Individual S
45 per cent – T Limited (owned by R)
A Limited: HM Revenue & Customs has confirmed that as long as the individual has control of the company in his or her own right – A Limited is controlled personally by X – the fact that the connected corporate holds shares will not prevent the ‘independence rule’ from being passed. All is well.
B Limited: This company fails to satisfy the rule as R does not have control in his or her own right but will have control when you include the corporate shareholding of T Limited. This company cannot grant EMI options or seek EIS/EIS investment.
Stephen Deutsch is a senior tax specialist at BKL Tax, a UK200Group member firm.