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13 September 2018
HMRC regards the award of unquoted shares to employees as a taxable benefit in kind in certain cases. The question is if tax is payable how much? The position is complex because there is no market for the shares against which the value of unquoted shares can be determined. But, this will not stop HMRC from collecting tax. We provide guidance.
Please do call us to discuss your position. We do provide fee estimates.
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. Tax can arise on award, exercise and or sale depending upon the circumstances. Taxable events include:
If the shares decline in value after the award has been made HMRC will not refund any tax paid by the employee. Therefore the process of approaching HMRC on terms which are most likely to result in a reasonable tax assessment is important.
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. It is assumed that the shares can be transferred freely.
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, such as SEIS or EIS 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.
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 advanced with HMRC will depend upon the business sector and the desired outcome.
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.
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.
In practice, we agree discounts with HMRC to the taxable value of unquoted shares for:
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:
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.
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.
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.
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:
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.
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.
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.
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.
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.
HMRC make this whole area very complicated but with the guidance we received we were left feeling much more comfortable.
The ability of the team to deal with the legal drafting and the tax issues proved extremely helpful.