We recently advised a private company who was considering gifting shares to staff.

The company was in the process of awarding shares to its employees through a regular share issue. They sought our advice on the tax implications if the employer gifted the shares so that the employees received the shares at no cost. There were also some self employed consultants who the company wanted to reward by the issue of shares at no cost.

When shares are gifted to employees or transferred at less than their market value, the benefit of receiving shares (or undervalue) will be taxed as employment income in the tax year in which the gift is made. The employees and consultants must report the issue of shares on their self-assessment tax return and pay the tax. Clearly it is in the interest of the employee that the shares are valued as low as possible.  The question is how much tax will be payable?

The problem – working out the tax payable on a gift of shares

HMRC will have 12 months from the day of the return to challenge the valuation of the shares by opening an enquiry. If insufficient tax has been paid by the employees (or consultants) they are liable to interest and often more costly penalties, which can be up to 100% of the unpaid tax.

The problem is that HMRC do not provide an indication of the taxable value of shares. In practice, the question only comes to light if HMRC raises an enquiry following submission of the tax return. It is hard to predict the approach HMRC will take on share valuation in private companies.

In our client’s case it was particularly difficult to predict HMRC’s approach as the company had an investment round prior to the proposed gift of shares based on a commercial valuation of £300 per share. What we do know is that HMRC will consider previous transactions in the Company’s shares.

The risk with gifting shares

Gifting shares brings the following problems for employees or consultants:

No certainty on the taxable value of shares

We were concerned that HMRC would take the view that the commercial value placed on the Company under the investment round was representative of the taxable value of the shares.

We do know that HMRC base the value on a fiscal valuation. This valuation will be different to a typical commercial valuation considered by an investor.  There are no firm guidelines issued by HMRC on how to work out the fiscal valuation.  Every specialist will give a different answer.

Meanwhile the employees and consultants do not know when they submit their tax return and pay tax whether they have calculated the correct amount.

To help reduce the risk we worked with the employer to provide an indication of the likely position.

The employees and consultants did not have spare cash with which to pay the tax bill.  We suggested that they be awarded bonuses which are used to pay the tax.  We worked through the grossing up calculations. The bonus payments were deductible for corporation tax purposes.

Anxiety for staff

The process that has to be followed with HMRC to arrive at a final determination can be very unsatisfactory to the employees who will face uncertainty for quite a long period as to what their tax liability will be. If the employee reports a value which turns out to be lower than the HMRC’s idea of the value of the shares, then the employee is liable to interest on the unpaid tax and at the discretion of HMRC penalties.

Shares decline in value

Another risk for employees and consultants is that if the Company does not perform and the share value drops below the taxable value, HMRC do not offer any refunds of tax. Instead, in some cases the individual will have to make a negligible value claim.

Awards to consultants

The position on how consultants should report share awards to HMRC is not free from doubt. There is no specific legislative guidance.

HMRC reporting obligations

Employers do have to report the award of shares to employees by 6 July each year following the award. Reporting is via the PAYE reporting portal. HMRC provide no guidance on whether reports should be made for consultants. Best practice is to report awards of shares to consultants along with employee share awards.  The employer is required to report the taxable value of shares awarded.  If the employer report does not match up with the taxable value reported by employees this increases the chances of an enquiry or review.

Possible solutions to avoid some of the problems with gifting shares to employees or consultants

We discussed other choices available to the Company.

Enterprise Management Incentives (EMI) share schemes

For employees we recommended EMI options.

Advantages of EMI options:

  1. The difficulties in determining the taxable value of shares on award does not arise with EMI options. EMI options can be structured so that tax is only payable when the shares awarded under EMI option are sold. The rate of tax is 10%.
  2. The risk of the shares declining in value is avoided. If the Company does not perform as expected the employee can let the option lapse.
  3. The employees do not carry the same responsibilities of reporting to HMRC that arise with share awards.
  4. If the shares under EMI option are to be acquired at nil cost we can negotiate the value of the shares with HMRC in advance of grant of the EMI option to provide certainty in terms of any tax exposure on exercise.
  5. EMI options do not carry any shareholder rights such as voting rights or dividend rights, so the employees do not get a say in decision making in the company.
  6. A major attraction of EMI options is that the employer is entitled to a corporation tax deductions based on the income tax that would have been payable by the employee on exercise if the option was not an EMI option.

Ideas for consultants being awarded with shares

Consultants are not eligible for EMI options.  The ideas for consultants are more limited.  We considered unapproved options which are relatively easy to implement but which do not carry any particular tax advantages.  In our client’s case there were only two consultants receiving shares and the decision was taken to award them with unapproved options.

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