Taxation » Flowering shares

Tax charges on flowering shares

What are flowering shares?

A special class of share offered by a company to its employees which start off with a low value as they have few rights when allotted, but automatically obtain enhanced rights if certain hurdles are met and as a result a much higher value. An example of such a right would be the right to participate in a sale of the company.

Tax charges

The main aim of flowering shares is for any in value of the shares to come within the capital gains tax regime of 28% for taxpayers with combined income and taxable gains above the income tax basic rate band or 18% for taxpayers with gains below that rather than the income tax regime of up to 50%. In addition the employees may be able to benefit from entrepreneur's relief on the first £5million of any gain if certain conditions are met.

For example:

A £1million gain treated as income will be taxed as follows:

  • Income tax on £1million @50% = £500,000
  • NICs (employers and employee) @ 12.8% = £128,000
  • Total tax deduction = £628,000
  • Total received by employee = £372,000

A £1million gain treated as a capital gain which qualifies for entrepreneur's relief will be taxed as follows:

Of £1million gain, £444,444 is exempt (4/9 of £1million) and the remaining £555,556 is taxable at 28%.

£555,556 @ 28% = £155,556

Total tax deduction = £155,556

Total received by employee = £844,444

How to secure best chance of CGT liability

  • Ensure the shares fall within one of the relevant tax charging provisions in Chapter 2 of Part 7 of ITEPA 2003 (restricted securities).
  • The employee should pay an amount believed to be at least the ful unrestricted market value at the time the shares are acquired (on the basis of the valuation prepared for the purposes of the acquisition) and, as a precautionary measure, both the employer and employee should make an election under s431 of ITEPA 2003 for the employee to pay tax up front on any discount to the unrestricted market value which will ensure that any income tax arises at the time of the acquisition and not later.
  • Ensure careful drafting of the rights attaching to the shares to reduce the risk of income tax charges under any other relevant tax charging provisions, for example conversion rights or post acquisition benefits.

Flowering shares are flexible and the employer has an awful lot of discretion in what he does and does not give away. In most cases it is prudent to agree the flowering share values with HM Revenue and Customs to provide certainty over the tax payable on any upfront charge when the employee receives the shares.

Flowering shares have certain advantages over shares allotted pursuant to an EMI scheme. EMI schemes have a number of limitations which may result in the company or individual not qualifying for example in order to qualify the company must have fewer than 250 employees, the maximum entitlement for each employee is £120,000 and the maximum value of shares under EMI option is £3million.

Future changes

The March 2010 Budget and the June 2010 Budget referred to plans for an HM Treasury review of the tax treatment of "geared growth" arrangements such as flowering shares. It is therefore worth considering flowering shares sooner rather than later since this reduces the impact of any new or retrospective legislation destroying the benefits for you.

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