There are complicated HMRC tax reporting and tax payment rules when unquoted shares are provided to employees or directors by their employer. The main issue is there is no established market valuation in private companies. So the question is how much tax is payable? We provide guidance.
Please do call us to discuss your position. We do provide fee estimates.
Specialists for the reporting and payment of tax on unquoted shares
- We can look at all of the issues relating to valuation and taxation of shares.
- Many of our clients come to us having worked with larger firms but now seeking value for money and good service.
- We can agree with HMRC the value of shares on grant under EMI option or the value of shares which have restrictions imposed such as growth shares.
Based on the questions we are asked we have put together a guide to help you deal with unquoted shares tax valuation.
When does tax arise if shares are provided to employees
There are many events relating to giving unquoted shares provided to employees or directors by the employer which give rise to a tax liability. If a tax liability arises it is necessary to establish the “taxable value” of the unquoted shares 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:
- Exercise of options;
- Gift of shares; and
- If share rights are enhanced.
Basic tax rule
The basic tax rule is that if the employee or director is given shares for free or pays less than the “taxable value” a charge to income tax and sometimes national insurance will arise. Unless the employee or director has paid at least the taxable value on acquisition of the shares there is a deemed benefit in kind arising. The benefit in kind must be reported to HMRC by the employer and the employee. And, the employee in unquoted companies is responsible for paying the tax due on the benefit in kind.
In quoted companies or companies where there is a market into which the employee can sell his shares the tax is collected under PAYE.
Decrease in value of the unquoted shares
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 assessment of the taxable value is important.
Similarly if the employee is forced to transfer his shares at a nominal value under good and bad leaver provisions set out in the articles there will be no refund.
Methodology used by HMRC
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.
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 advanced with HMRC will depend upon the business sector and the desired outcome.
HMRC do accept that restrictions reduce the taxable value of unquoted shares. We consider the nature of the restriction and the commercial implications. The restrictions must be set out in the articles or shareholders agreement.
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 can be discounted to reflect the degree of control over the company’s affairs.
- 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.
Pointers for employers
We do handle the award of shares or options for employees including negotiations with HMRC. The main areas where we help include:
In some cases elections are needed to preserve the employees ability to pay capital gains tax on disposal of his shares. Without an election there is a risk that gains are assessed to the much higher rate of income tax and national insurance.
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.
Communications with employees
Share awards work 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.