Part paid shares
Our client needed advice on the tax position and possible tax mitigation where shares are partly paid.
Part paid shares corporate options for tax reliefs
The company was not eligible for EMI, and so could not offer a tax advantaged share option incentive. In addition, the majority shareholder did not want the company to alter its share capital structure, and so it was not possible to create a class of growth shares.
There was a reluctance to grant share options since the shareholders did not consider that options would provide a meaningful incentive. Further, it was felt appropriate that management should acquire a direct equity stake from the outset. This was to align their interest with existing shareholders.
Partly paid shares
The solution was to offer management the opportunity to buy a minority shareholding on a nil paid basis with the purchase price left outstanding. The reason why the purchase price was not paid up-front, at the time of subscription, was because the valuation of the share stake offered was considered to be too high for management to purchase their shares outright.
The company had recently agreed a commercial valuation of its shares as part of an investment in the company. It was decided this valuation was more than the tax (fiscal) valuation of a minority stake that management would be purchasing. The company sought advice from a share valuation firm which determined a per share market value for management’s purchase to be set at a discount of 70% to the commercial valuation.
The company’s board of directors considered that the valuation would be supportable as the tax market value for the purpose of management subscribing at that price but with the purchase price left outstanding. It was agreed that the purchase price would be payable by management over four years (the vesting period), with early payment in the event of an exit.
Tax and reporting the acquisition of partly paid shares
Management entered into subscription agreements for their shares. Shares subscribed were not subject to the achievement of any performance conditions, aside from the liability to pay up the shares over a four year vesting period.
Management’s outstanding purchase price for their shares is treated as if it were a loan made by the employer. The amount outstanding each tax year gives rise to annual benefit in kind (BIK) charge. There is also employer’s only NIC on the annual BIK.
The company is not expecting to release management from their obligation to pay the purchase price; (if that were the case, PAYE/NIC would be due on the amount released). Assuming a rising share price, if management sell their fully paid up shares in the future, all gains realised on sale should be taxed to capital gains tax (i.e. no PAYE/NIC should be due on the sale proceeds).
Management were required as a condition of their subscription to enter into a section 431 ITEPA tax election with their employer and within 14 days of acquiring their shares. This election is important because it dis-applies income tax (including PAYE/NIC) from arising when the shares are sold under the restricted shares legislation (shares acquired by management would be within scope of this legislation because the shares they acquire are subject to restrictions in the share subscription agreement and the company’s articles of association).
HMRC reporting obligations
Employers have to report the award of shares to employees by the 6th of July each year following the award. Reporting is done via the PAYE reporting portal.
Catherine is an extremely experienced solicitor, having been qualified since 2000, and deals with all types of corporate and commercial matters and advice and also tax law.
Catherine is well known for turning complex problems into solutions, priding herself on always finding a way. In her spare time she runs Gannons!