Calculating the taxable value of shares
HMRC regards the provision of unquoted shares to employees as a taxable benefit in kind. The question is how much tax is payable? The reason for complexity is there is no market for the shares against which the value can be measured. However, this will not stop HMRC from assessing tax and interest if sufficient tax is not paid. We provide guidance on the unquoted shares tax valuation.
Our services relating to unquoted shares tax valuation include:
When to determine the taxable value of unquoted shares
There are many events relating to unquoted shares provided to employees or directors which give rise to a tax liability. If a tax liability arises it is necessary to establish the taxable value in order to pay the correct amount of tax. Events include:
- Exercise of options;
- Gift of shares, alphabet shares and restricted shares; and
- If rights or restrictions are added or removed from shares.
Advance clearance from HMRC
HMRC are prepared to review the taxable value of shares before awards are made. This is a helpful service as it provides clarity for employers and employees. However, advance clearance from HMRC is only available if the employer is proposing to grant EMI options or CSOP options.
Situations where advance clearance from HMRC cannot be obtained
There is a wide range of situations where a tax liability arises and there is no opportunity to agree the taxable value in advance with HMRC. Our service is to guide employers on behalf of their employees on the taxable value most appropriate for the basis of HMRC reporting and payment of taxes.
Methodology behind the taxable value of unquoted shares
In some cases, the taxable value is based on a concept known as “actual tax market value”. In other cases the taxable value is based on a concept known as “unrestricted tax market value”.
Different businesses require different valuation methodologies. There is no standard approach to share valuation. HMRC apply a concept of open market value. Open market value is based on the hypothetical assumption there is a willing buyer and a willing seller.
HMRC will accept that start ups have limited assets, and no trading history. The taxable value of the shares is usually agreed by HMRC to be low.
If the start up has received investment that will have to be disclosed to HMRC as part of the process of agreeing the taxable value of shares awarded to employees or directors. However, in many cases we secure sizeable discounts to the pricing of any investment round.
Established trading companies
For established trading companies the taxable value of shares provided to employees or directors requires analysis of a variety of different valuation methodologies. The methodology we recommend is adopted with HMRC will depend upon the business sector and the desired outcome.
Range of methodologies
The three most common approaches are to calculate the taxable value of the shares based on a price earnings multiple, dividend yield or asset basis. It is not unusual to see a combination of approaches adopted.
Price earnings multiple
The price earnings multiple is the most common for companies with a trading history. It requires an assumption of a sale at a value based on the price earnings multiple for a similar quoted company to the company in question.
With unquoted companies it is usually difficult to find a direct quoted comparator. This is one of the points we negotiate with HMRC to establish the lowest quoted company comparator.
HMRC accept that a discount arises for an unquoted company because an investment in an unquoted company is theoretically more risky than that into a quoted company.
Unquoted shares tax valuation – discount considerations
In practice, we agree discounts with HMRC to the taxable value of unquoted shares for:
- Restrictions on the shares;
- Minority shareholdings
Discount to taxable value for restrictions on shares
HMRC do accept that restrictions reduce the taxable value of unquoted shares. We consider the nature of the restriction and the commercial implications. Typical restrictions relate to:
- A requirement that an employee or director transfers his or her shares to the company and or other shareholders on leaving employment;
- Removal of dividend or voting rights;
- Imposition of hurdles often seen in growth shares which have to be achieved before rights arise. The most common restriction with growth shares is removal of the right to receive capital payments on sale of the shares if targets are not satisfied;
- Discount to the taxable value for a minority shareholding.
Unless the whole shareholding is sold, the value of the shares should be discounted to reflect the degree of control over the company’s affairs. Discounts reflect the shareholder rights in the Articles of Association which can be interpreted to reduce the taxable value of unquoted shares.
Discounts apply to:
- Price earnings (PE) ratio when valuing a company with low levels of debt; and
- EBITDA when valuing a highly geared company
HMRC does not give guidance on discount levels. The discounts have to be negotiated and agreed with HMRC on a case by case basis. Understanding how restrictions on shares in Articles of Association work in real life is instrumental in the negotiation process with HMRC.
Company A offers EMI option over ordinary shares which are subject to pre-emption and have no voting rights. Company B offers an EMI option to employees but the shares sit after the preference shares on winding up. Both companies offer options over 10% equity.
In case of Company A – HMRC may agree a lower level of discount than for Company B. The size of the discount depends on the nature of the preference given to Company B preference share holders.
HMRC does check on the market speculation regarding the value of a company. They look into possible trade sales and IPOs in the press. Market intelligence and press coverage has to be addressed. Often it is not accurate and may lead to an inflated unquoted shares tax valuation.
Unquoted shares tax valuation – HMRC reporting and payment obligations
Employees will need to report the award of shares in unquoted companies on their personal tax returns. The responsibility for payment of tax on the taxable value of the shares awarded rests with the employee. The exception is where the shares are “readily convertible assets” in which case the employer is required to deduct income tax and national insurance under PAYE.
Readily convertible assets
HMRC considers an unquoted share is a readily convertible asset if there is a market for shares.
Typical situations where HMRC will consider there to be a market for the shares and impose a PAYE obligation on employers include:
- The business is about to be sold or has entered into heads of terms for sale;
- There is an employee benefit trust able to acquire the shares from the employee; or
- The company is about to be quoted on a traded exchange.
Reduction in the values of shares post award
When the employee acquires shares he pays income tax on the taxable value which is usually calculated at the time of the award. If subsequently the value of the shares goes down the employee does not get a repayment from HMRC.
Employer reporting and payment obligations to HMRC for unquoted shares
There are a variety of HMRC reporting requirements for employers. Employers do have to submit tax returns in respect of all share awards and options.
In cases where a PAYE liability arises on readily convertible assets timing is a problem. Often PAYE has to be operated before the unquoted share tax valuation is determined. We support employers through the reporting and payment of tax to HMRC.
Unquoted share communications with employees
Share awards work only when employees realise how much value they are getting. However, employees often find valuation and taxation of share schemes confusing, especially the income/capital aspect. They do not want to be hit with a large tax bill and worry whether they will get their tax return right.
We draft communications for employees in a way they will understand.
Liability for employers
Employers who do not inform their employees of the full implications of the unquoted share award may be found culpable. A recommendation to seek expert advice can be a good message to send to employees.
Employers need to be careful not to give investment advice to employees. There are unwanted repercussions for employers who are not authorised to provide financial advice but who break the rules.
Challenging HMRC determinations on the taxable value of unquoted shares
We do handle challenges from HMRC relating to unquoted shares taxable value.
Apart from the risk of additional tax to pay, there is the risk of interest and penalties for employees and employers on the incorrect submission of tax returns. HMRC have been steadily increasing the penalties which can now be sizeable depending upon the facts.
The penalty regime enables HMRC to assess tax of up to 100% of the tax payable. HMRC operate a sliding scale based on culpability. If the employer can demonstrate it was not negligent and took appropriate advice on the taxable value of shares provided to its employees or directors the chances of a large penalty will be reduced.
Recent work involving unquoted shares tax valuation
Our recent instructions include:
- Preparing a share option valuation for the purposes of a CSOP scheme for a major tour operating company;
- Agreeing a share valuation for a CSOP awarded by a content monetisation company;
- Share valuation for the purposes of an EMI option plan for key employees of an IT company;
- Agreeing with HMRC the taxable benefit in kind when voting restrictions on shares in a private company were lifted.
A share valuation is an integral part of a well thought out and a well designed share plan. It helps avoid unwanted tax charges and assists with future share and option awards.