§ Mr. FlightI beg to move amendment No. 144, in page 313, line 34, at end add
'Where an option does not qualify by reason of an error in the scheme pursuant to which it has been granted, but would otherwise have been capable of being a qualifying option pursuant to paragraphs 9 to 17 inclusive of this Schedule, then that error may be corrected and be deemed to have been always corrected from the date of grant of the option.'.
§ Mr. Deputy SpeakerWith this it will be convenient to discuss the following: Amendment No. 143, in page 314, line 24, at end add—
'(4) In the event of the requirements of this Schedule being found not to be met in relation to an option, whether upon enquiry by the Inland Revenue or following an appeal, there shall be no right of action in tort or contract either in favour of or against the relevant company or any employer company.'.
§
Amendment No. 142, in page 316, line 2, leave out from beginning to end of line 3 and insert—
'At any one time there may not be qualifying options in respect of shares in the relevant company over shares with a total value of more than £1,500,000. For the purposes of this paragraph shares shall be valued according to their market value at the time that the option granted over them is granted.'.
§ Government amendment No. 61.
§
Amendment No. 141, in page 328, line 21, at end insert—
'(4) Where pursuant to any provision of this Schedule an individual becomes liable to income tax then notwithstanding any other provision of the Taxes Act 1988, the tax due shall be paid in five equal instalments as follow—
§ Government amendments Nos. 62 and 63.
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§ Mr. FlightAt first glance, the enterprise management incentives appear to be extremely generous and attractive schemes to encourage entrepreneurs and key leaders of business. Regrettably, however, as we pointed out in Committee, there are several problems, one of which is that a large number of business areas have been excluded, based on views founded in the past. A larger problem has been raised by several accounting and law firms specialising in the matter: that if the business in which people are granted EMI options succeeds—and therefore the options become worth something—it will almost certainly have disqualified itself by that stage; so, although individuals might enjoy EMI tax advantages for a year or two, they will quickly cease to do so.
Our amendments relate to the issues thus raised, which reveal the proposal as being more spin than reality—perhaps I should call it underspin. What is the estimated tax cost of the scheme? That would provide a reasonable measure of the extent to which the Government expect it to be effective. According to Government calculations, are EMI schemes a major means of fiscal incentivisation, or am I right to fear that they are merely a case of nice presentation with limited practical application? Before addressing our amendments, I should say, in passing, that the Opposition support the Government amendments, which, as the House will agree, are practical measures.
420 Our amendments are further practical measures that relate to the themes that I have identified. The first issue is the self-certification system, to which amendment No. 144 relates. Business wanted self-certification, which is a good idea, but it might engender some unnecessarily wrong outcomes. Currently, both employee and employer have to take a chance that the option scheme might not qualify; they have to wait to see whether the Revenue agrees with the employer's view that it does qualify. Therefore, the amendment embodies a reasonable suggestion whereby the correction of technical errors should be allowed where it is clear that the company and its arrangements should have been capable of qualifying. There is a difference between a scheme that is clearly outside the key parameters and rules, and one that contains, say, a drafting error that has resulted in the Revenue not granting its approval. Past comparable arrangements provide precedents whereby the Revenue is permitted retrospectively to correct what are described as remediable errors, as opposed to major errors of principle.
Amendment No. 143 relates to similar territory. Because it is not known at the time of grant whether a scheme will qualify, there is clear scope for legal action if an employee has been led to believe that it will qualify and then finds that it does not. The employer is asked to bear the risk, so we suggest that it should be permissible to give an indemnity against such actions, to avoid the process being impeded by legalese and caveats, which might discourage genuine cases of schemes that should have qualified.
I am referring to our amendments in reverse numerical order, as they appear on the selection list, which means that amendment No. 142 is next. It represents our attempt to create somewhat greater flexibility within the basic parameters whereby no more than £1.5 million can be awarded under EMI options. The amendment would introduce the principle whereby, instead of there being an inflexible maximum of 15 employees, there should be an aggregate limit constituting the total sum of all qualifying options. As Ministers will note, our amendment is worded so that one person will be prevented from awarding himself the whole lot. The current provisions might produce unnecessary anomalies, given the contrasting nature of different businesses. If a company needed to recruit 16 key people and a perfectly adequate market allocation was £50,000, it could not do so under the present rules; similarly, if the key number of people required was seven, but in the very competitive, new economy area, where £100,000 as an allocation was on the low side, it would not be permitted. Our amendment would provide a little flexibility within a limit of £1.5 million and would cater for the different needs of businesses.
Amendment No. 141 proposes arrangements that have been used quite successfully in this country in the past, which, in essence, stagger the payment of tax. It relates to the situation in which after an individual has enjoyed EMI terms for the first two years, the company grows and the individual ceases to enjoy the terms. When he or she exercises the options, there will be substantial income tax liability. The amendment would introduce the principle of instalment payments for the income tax that would fall due on the exercise of the EMI option, and it follows the provisions on payment of income tax on share options that prevailed before 6 April 1984, updated to reflect the introduction of self-assessment, which was not then in operation.
421 The amendment also removes the gain from the operation of pay-as-you-earn, providing for payment in five instalments. The first would be on the normal self-assessment date and the others on successive anniversaries of it. It is necessary to take account of the special nature of EMI companies. If the tax were collected via PAYE, the employer would have 30 days to raise it to avoid an additional tax charge under section 144A of the Taxes Act 1988, which states that if an employer receives benefits that are non-cash but PAYE-able, such is the gain made on the exercise of share options that a second tax charge on the amount of the PAYE due would be levied if the employee had not paid to his employer the amount of tax due within 30 days.
In practice, the amendment will force the employee to sell shares to raise the PAYE. PAYE applies where shares are readily convertible assets, which the Revenue defines and interprets widely, and which catches any listed company, and even unlisted companies in which it is considered likely that the employee might be able to realise cash from the shares, such as businesses that are about to be sold or in which flotation is pending.
Our proposal is designed to stop what would effectively be mandatory sales arising in situations in which a company has been successful and the EMI qualification has ceased. The Government will be advised by the professions that several problems arise in what is in principle an attractive scheme. Companies offering membership of a scheme to key staff will suffer uncertainty as to how long qualification will last, as to approval by the Revenue after the company's self-certification and as to the potential tax liability. Our amendments are designed to address those uncertainties and make the scheme more workable as regards its basic intent, which we support.
§ Miss Melanie JohnsonI do not intend to speak to the Government amendments as they are technical, correcting unintended double negatives and so forth.
The hon. Member for Arundel and South Downs (Mr. Flight) got a number of things quite wrong in his speech, and I hope to reassure him. He mentioned costs. The anticipated cost is given at page 154 of the Red Book—£45 million for a full year—and we anticipate that 2, 500 companies will take up the incentive in the first three years, which involves about 18,000 employees. That is the basis on which our figures were constructed.
Amendment No. 144 demonstrates a misunderstanding of how enterprise management incentives work. An EMI option is granted as part of a share option scheme, but it is possible that a company may wish to grant EMI options to key employees under the rules of such a scheme. Nothing in the schedule requires that, however, and the schedule does not refer to a scheme as such. In addition to the reference to a scheme in the amendment, the hon. Gentleman spoke about schemes a few moments ago, but the schedule does not require the establishment of a share option scheme with rules to govern the granting and exercise of options.
6.15 pm
One requirement is that a company is carrying on a qualifying trade, but if it was not, it would not be possible to go back in time to suggest that it had been carrying on a qualifying trade at the date when the option was granted. 422 That being so, we would not want to deem the option as having been a qualifying option from the outset, if the company decided that not carrying on a qualifying trade was an error and changed its trade to correct it. That would set an extreme and unwelcome precedent, and I cannot think that Conservative Members would think that sensible or desirable.
if, however, amendment No. 144 indicates concern that the company will be unfairly penalised if it has accidentally provided incorrect information when notifying the option to the Inland Revenue, I can allay that concern. The schedule already makes provision, at paragraph 3, for errors to be corrected in the notice to the Revenue. The provisions are equivalent to those provided under self-assessment for companies or individuals to correct any mistakes in their return.
The schedule also makes provision for the grant of an option over shares with a market value exceeding the individual limit of £100,000. Paragraph 10 allows any excess to fall outside the EMI provisions without disqualifying the whole of the option. Any error in the option agreement itself would be a matter between the grantor of the option and the employee. If they agreed to change the terms of the option, and the change related to something not required by the schedule, that would not in itself be a reason to disqualify the option, unless the effect were to increase the value of the shares under option. Amendment No. 144, with its reference to correcting errors in a scheme, in fact addresses an issue not relevant to the schedule. For those reasons, it is unwelcome and unnecessary.
Amendment No. 143 would have far-reaching consequences that the hon. Gentleman may not appreciate. It seeks to prohibit claims in tort or contract from being brought by or against any relevant company in the event that an option fails to meet the requirements of schedule 14. It is not clear why anyone would wish to protect companies against civil actions taken against them, or prevent them from bringing such actions, simply because the action was in connection with an option that failed to meet the criteria for EMI. I can see no reason why the employee—or employer—should lose his or her rights under civil law because he or she has become involved in the grant of an option intended to qualify under EMI.
If, for example, a company had deliberately misrepresented an option to an employee as qualifying for EMI, that employee might well feel that he or she had a legitimate right to challenge the actions of the company in court. That could lead to an anomalous situation. An employer may grant two identical options to two employees—one notified to the Revenue under EMI and the other not. It might be that neither would meet the EMI conditions, but once it was discovered that the first option did not meet the EMI criteria, the employee would have no redress against his employer for any failure to meet his contractual obligations, or any negligence or deceit involved in granting the option. The other employee—with exactly the same right to acquire shares—would retain his rights under civil law. The amendment would give too many powers away as well as raising questions under the European convention on human rights.
Amendment No. 142—it was dealt with as amendment No. 194 in Committee—would allow a company to grant options under the EMI provisions to as many employees as it wished, up to a limit of £1.5 million. The amendment goes against the whole aim of EMI, and against all the 423 recommendations made to us by business experts. As I have already explained in Committee, EMIs are a targeted measure for key employees—those who really make a difference to smaller, high-risk companies.
In Committee, I provided details of the reports backing EMI which appear at column 515 of Committee proceedings on 6 June. I could list them again, but I did list them all then. A report by the Bank of England on financing technology-based firms, a report by the Confederation of British Industry on technology stars, and the Government's own study group, chaired by Sir Peter Williams, chairman of Oxford Instruments plc, all found that the main barrier to growth experienced by smaller high-risk start-up businesses was a lack of highly qualified and motivated key employees. Those studies recommended targeted tax relief to help solve that specific problem, not general relief for employees to pay less tax.
EMI is the response to that and provides targeted tax relief. If companies want to, they can grant options to all their employees under not one, but two tax-advantaged share schemes: the company share option plan and the save-as-you-earn savings-related share scheme. A third such scheme is not necessary, as the matter is not about companies being to able to grant those options to all employees.
Amendment No. 142 would produce another unsatisfactory result. EMIs are simple and quick to operate, and do not require an approvals process. They have been designed that way because smaller companies have told us they want an incentive that is simple to operate and flexible, so that it can be designed to suit the individual needs of a particular business situation. If EMIs could be extended to all employees, having a company limit of £1.5 million rather than a limit of £100,000 per individual would require much more administration or red tape. I am sorry that the hon. Member for Buckingham (Mr. Bercow) is no longer in his place, as he was complaining earlier about red tape. The amendment would increase the amount of red tape and would involve keeping track of all option grants and exercises to ensure that the limit was not breached and all the employees' tax relief lost as a result.
The hon. Member for Arundel and South Downs asked about disqualification. He claimed that the options will almost certainly have disqualified themselves by the time that the company is successful. There is no disqualification if the company grows above the initial limit of £1.5 million of gross assets. The test applies only at the time that the options are being granted, so the issue foreseen by the hon. Gentleman does not arise. During our extensive consultation, everybody, including an advisory group of experts that helped the Inland Revenue to draw up the legislation, commented that smaller companies have only a limited number of key employees and welcomed the increases that we made to the number, initially from six to 10, and then from 10 to 15. There has also been a welcome for the great flexibility of this incentive.
Amendment No. 141 addresses issues which, again, are based on a misunderstanding. For the most part, no one will pay any tax as the result of being granted EMI options. Under normal circumstances, people will not pay tax when they exercise the option, if they were granted the option at market value. EMI is a very flexible 424 instrument and allows companies to structure option agreements that could provide a gain to employees for reasons other than the intrinsic growth of the company. For example, companies can offer employees an option at a discount or at no cost at all, or can offer them an option that is immediately exercisable. Normally, there is no charge to tax under EMI on the exercise of a market value option. But when the option is granted at a discount, the normal taxing provisions apply to the part of the gain that relates to the discount. Only the discounted element will then be taxed. The charge arises under the normal charging provisions on share option gains, including section 135 of the Taxes Act 1988. EMI option holders are treated in exactly the same way as any other taxpayer in relation to the chargeable amount.
EMI has been deliberately designed to target the relief on gains arising from genuine growth in the value of the company. That rewards the employee's contribution to making the company grow, rather than any gains that he may make because he has been granted options at a discount on the market price. If a discountable amount is taxed, we would defend that as being not part of the incentivisation, as it has been granted as part of the arrangement, as opposed to growth. In all other regards, under normal conditions, people are unlikely to pay tax. Therefore the proposal envisaged in the amendment is not necessary.
I cannot see a case for providing for EMI option holders a special rule for paying tax over five years on taxable gains which do not fall within the schedule's targeted tax reliefs. In fact, we agree that the revived rules seem to fall in with the rules that the previous Conservative Administration looked at and which they acted against in the Finance Act 1984, when they restricted any payment in instalments to options granted before 6 April of that year. We agree with the previous Government's conclusions that the advantages available to companies under the approved schemes mean that there is no need for special rules for paying tax on other gains. Any taxable gains arising from EMI options are in exactly the same position as gains from other unapproved options, and should be taxed after allowing for EMI relief under the same rules.
The problems envisaged by the hon. Member for Arundel and South Downs will not normally arise and, when they do, that does not present a difficulty, but an arrangement that fits in with other arrangements that we would defend. I hope that I have reassured the hon. Gentleman on a number of counts. On those counts on which I am not reassuring, but arguing that his proposals are unnecessary, unhelpful or complex, I ask him not to press his amendments.
§ Mr. FlightI thank the Minister for her full response to the matters that I have raised. I make the point upfront that the issues that I raised have been raised with me by Cisco, which is now called the Quoted Company Association, as well as several leading lawyers in the matter. For better or worse, they communicated to me that their key worry on EMI legislation as it stands is the lack of certainty. They will find what the Minister said helpful in addressing that worry.
Without misdescribing the matter as a scheme, however, when an individual gets his EMI qualifying options, there is an issue arising from self-certification. It is possible that the company may have made a minor 425 mistake, which the Revenue will pick up when it looks at it a year later and say, "Terribly sorry, there is something wrong." Consequently, the individual will not qualify. There is clearly an issue of materiality versus non-materiality. The Minister may be able to give me further comfort, as it is not entirely clear whether a relatively minor issue can be put right retrospectively.
§ Miss JohnsonI have already covered that point. As with self-assessment returns, there will be a period when the Inland Revenue or those on the other side can correct any matters. It is perfectly possible for genuine minor mistakes to be sorted out in that period.
§ Mr. FlightI thank the Minister for her clear and extremely helpful explanation. I agree that, if that is the case, the risk of EMI agreements getting cluttered with all sorts of legalese to protect businesses against the risk of being sued is probably not a major one. Therefore, amendment No. 143, which sought to address that risk in a rather heavy-handed fashion, is not necessary.
As the Minister said, the tight rules about 16 people and a limit of £1.5 million were discussed in Committee. Our amendment certainly is not intended to undermine the scheme's objective. The simple point is that how many key executives one needs in a business varies enormously, depending on the nature of the business. If the business is very much a selling business, there will be more key people, especially in the flat structure of companies, who will be the makers of success in that business. If the business is a concentrated high-tech producer and the selling is subcontracted, there will be infinitely fewer key employees.
The tariff of key people in different areas and different businesses varies considerably. As we said in Committee, we think that it is sensible to permit flexibility. We are glad that the Government have raised the number to 15, but in some areas there may be eight key people and the tariff may be £200,000, and in other areas there may be 20 key people and the tariff will be much less. I understand why the Government want to stick with the simplicity of the rule—that has its logic—but in consultation with companies, as opposed to venture capital professionals, they would find that there is unhappiness about this issue.
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I shall repeat our point about instalment payments to get it on the record. When an individual gets his grant of EMI options and the company qualifies, can he be sure that he will retain EMI tax status as long as he holds those options, even though the company may subsequently cease to qualify because of significant growth or for another reason? If the EMI status can change relatively easily beyond the date of grant, and the individual who has EMI options is not certain of retaining his EMI tax advantages, my basic concerns stand.
§ Miss JohnsonI repeat my earlier point, which answered the hon. Gentleman's question. There is no disqualification if a company grows above the initial limit of £15 million of gross assets. The tax-exempt status applies only at the date on which the option is granted. Obviously, it has to apply at that point so that the options can be granted under the EMI incentive. Subsequent growth by the company will not invalidate the fact that the options were granted at that point.
§ Mr. FlightI thank the Minister for that reply. The key issue is growth and success, but one could think of other factors that could invalidate the status. On the other hand, there is a question of principle: if there is qualification at the time of grant, does that make the EMI status valid for so long as the individual holds the options? If so, we do not take issue with the proposal. I shall give an example: the Minister, later in her career, will get her EMI options, but she cannot know whether anything will happen to her business or the way in which it conducts itself that will render her options non-EMI, and that will affect her perspective of their value when she receives them.
My understanding, and that of the lawyers to whom I have spoken, is that one's EMI tax status is not safe on all counts simply because the status applies at the time of grant. There are factors that could subsequently negate that status. The Minister kindly responded to my question about growth, but what about other issues?
§ Miss JohnsonI understand that change would not normally alter that status, but I am happy to write to the hon. Gentleman to cover any other eventualities. I cannot, at the moment, foresee any, but there may be some. Under normal circumstances, the individual who receives the tax advantage will continue to receive it through the EMI incentive. In the case of a disqualifying event other than company growth, the employee has 40 days to exercise and keep the relief; otherwise, the answer is yes: the individual will continue to receive the tax advantage through the EMI incentive.
§ Mr. FlightWe do not intend to press the amendment to a vote. There has been a useful airing of the issues. I look forward to further modest correspondence on the subject. It is clearly in the country's interests that the measures succeed in their objective. I merely say to the Minister that companies have expressed concerns to me and if the scheme is to work, they must be laid to rest. I beg to ask leave to withdraw the amendment.
§ Amendment, by leave, withdrawn.
§
Amendments made: No. 61, in page 321, line 8, leave out—
'at some time in the qualification period relating to the relevant shares'.
§ No. 62, in page 332, line 10, leave out "not".
§
No. 63, in page 332, line 36, at end insert—
'This is subject to sub-paragraph (3).
(3) Paragraphs 44 to 46 and sub-paragraph (2) of this paragraph do not apply if the amount chargeable under section 135 of the Taxes Act 1988 on the exercise of the option would, in the absence of those provisions, be less than the amount so chargeable by virtue of those provisions.'.—[Miss Melanie Johnson.]