Giving shares to employees
If you have a query please do call us. We are happy to provide a steer and a fee estimate.
Gifting shares to employees can motivate them to help build your business. However you need the right legal and structure.
We work with employers providing shares to employees and directors by way of a gift. We also review proposals for employees and directors.
Reasons to work with us
- Private companies are our core business area. We have the experience you will need to provide shares for employees. We understand the interaction between owners of a business and employees.
- Clients come to us because we combine the legal knowledge required in protecting shareholders adequately and legally, with taxation knowledge and share valuation expertise.
- We cut down on the need for many different sets of advisers.
Based on questions we are often asked, we have set out a brief guide for you.
- Structuring the gift effectively;
- Protecting shareholders from risks;
- Tax issues on gifting shares; and
- Implementing the gift.
Structuring the gifted shares for employees effectively
Statistics indicate that companies who provide shares for employees outperform other companies.
The benefit of holding shares is that the profits made on the sale or transfer of the shares gifted should be subject to capital gains tax as opposed to much higher rates of income tax and national insurance. We have explained more about the tax implications below.
How to provide shares for employees by way of gift
The shares for employees provided by way of a gift can come from either existing shares already owned by shareholders or from newly issued shares. Shares for employees can be given to employees free, at discounted rates or at any value determined by the directors.
Using existing shares for the gift
Existing shareholders might agree to transfer a proportion of their existing shareholding as gifts to employees. Unfortunately, this counts as a disposal for capital gains tax purposes. This route’s attractiveness depends on the capital gains tax bill that results from the transfer. In addition, employees would receive dividends at the same rate as the shareholder who gifted the shares.
Existing shares – dilution
A benefit of using existing shares is that there is no dilution for other shareholders.
Issuing new shares
Using newly issued shares for the gift employee has some tax benefits for existing shareholders. The advantages are:
- The newly issued share route does not carry a capital gains tax charge for existing shareholders.
- You can create a new class of shares for employees. The dividend rate paid on shares held by employees could differ from the existing shareholders’ dividend rate.
There are reporting obligations at Companies House when shares are issued.
Newly issued shares – dilution
Newly issued shares dilute existing shareholders’ shareholding. It is possible to confine the dilution to specific shareholders. However, confining dilution can give rise to a tax charge for existing shareholders if they are caught by the anti-tax avoidance value shifting provisions.
Compared to an existing share transfer, newly issued shares are usually preferred.
Protecting shareholders from risk when gifting shares to employees
When an employee leaves, unless otherwise stated, the employee retains the gifted shares. So, ex-employees continue to benefit from the company’s growth. Ex-employers can even stall an exit by refusing to sell the shares. The way around the problem is to include provisions in the company’s articles of association and the shareholders’ agreement.
Use of good and bad leaver provisions when gifting shares
It is common to distinguish between good and bad leavers. Good leavers leave because of e.g. death, disability or the directors want them to continue to benefit. Bad leavers are usually anybody who is not a good leaver and who does not continue to benefit from the company’s growth.
Retaining the ability to exit
If the company is sold, the employee will be treated as any other shareholder. It will be important to make sure that the articles include appropriate drag along rights to protect the other shareholders from the risk an employee does not agree to sale. Without drag along rights the business may be unsaleable.
Restricting the rights of shares for employees
It is possible to provide different rights to different types of shareholders. For example, upon a gift of shares to employees, rights to voting may be restricted. The restrictions are usually dealt with via an amendment to the articles. For tax purposes it is preferable to deal with the restriction before the employee is awarded the shares. This is because restrictions lifted after the employee has become a shareholder can cause unforeseen tax liabilities.
Tax payable on the gift of shares
The issue of gifting shares to employees contains some of the most draconian anti-avoidance legislation within HMRC’s powers. What should be simple, can be extremely complex. Unexpected and unplanned tax liabilities easily arise. Tax needs to be considered:
- On the gift of shares; and
- If once the shares are gifted the rights are varied in any way; and
- Upon the sale or transfer of shares.
Basic income tax rule applying on the gifting of shares to employees
The basic rule is if an employer gifts shares to an employee, then the employee is deemed to be in receipt of a benefit in kind on which income tax and sometimes national insurance is payable.
Having paid the tax on the shares at the time of gift, the idea is that the profit made on sale or transfer is then taxed as capital as explained below.
Using a bonus to settle the employee’s income tax liability
Employers gifting shares in businesses which are trading and making profits will need to consider how employees will fund the tax liability arising on the gift of shares.
One option is to vote the employees a bonus. This bonus covers the tax liability. Bonus payments attract income tax and national insurance. However, the employer can use the bonus payments to reduce their corporation tax bill.
Changing the rights attaching to shares once gifted
Changing the rights attaching to the shares after the initial gift and payment of tax on award can give rise to further tax changes. It can also mean that on sale some of the proceeds are subjected to income tax and national insurance rather than the lower rate of capital gains tax. There are ways to eliminate the risk which we do explain to employers.
Valuation of shares gifted to an employee
Providing shares for employees in private companies requires a valuation of shares. This is to ascertain the tax payable on the gift. Valuing the shares in private companies where there is no ready market for tax purposes can be complex. However, the amount of tax payable by the employee or director on the gift of shares will hang on the valuation HMRC places on the deemed benefit in kind.
We do undertake negotiations with HMRC for employers and employees.
Dividends are taxed at lower rates than income and do not incur employer’s or employee’s national insurance. They are more tax efficient than salary.
Warning for employers relating to dividends
There will be tax issues if HMRC assess that the employer has paid dividends in place of salary. Meticulous board minutes justifying decisions should be made contemporaneously. Within the HMRC armoury is a body of anti-avoidance legislation known as the disguised remuneration rules which, if imposed, will decrease the tax advantage of receiving dividends.
Sale or transfer of the shares gifted
The intention is that the employee will make a gain on sale or transfer and that gain is assessed to capital gains tax. The rate of capital gains tax is much lower than the rate of income tax and national insurance on equivalent profits.
Business Assets Disposal Relief (Entrepreneurs’ relief) is available if the conditions are met which bring the rate of capital gains tax down from 20% to 10%.
The company can buy the shares back from the employee as it could from any other shareholder. The employee can qualify for the tax beneficial treatment on a buy back of shares.
Illustration of how a gift of shares can work for tax purposes
Say the ordinary shares are currently worth £10 per share. Say a new class of employee shares is created with compulsory transfer provisions on leaving employment and no veto rights. Say the unrestricted tax market value of the employee shares was agreed with HMRC at £5 per share. The company at £100 per share.
If the employee paid £5 per share on award there would be no income tax or national insurance payable. On sale there would be a capital gain of £95 per share subject to capital gains tax.
If the employee paid nothing for the shares on award there would be an income tax and possibly a national insurance charge payable on award calculated on £5 per share. For a 45% tax payable the tax would be £2.25 per growth share. If the employment ceased there would be no refund from HMRC of the tax paid. On sale there would be a capital gain of £95 per share subject to capital gains tax as account is taken of the amount already assessed to income tax.
Implementing the gift of shares
There are a number of steps for employers to consider before gifting shares to employees. Some of the key steps include:
Is there a better alternative to gifting shares to employees
We can take employers considering providing shares to employees through all the options available. Many private companies adopt EMI options as they are flexible and very tax efficient.
If EMI options are not suitable or attractive there are alternatives that can be considered.
Recording the gifting of shares
The employer should record the details relating to the value of the shares when they are gifted. This is because records will be required when dealing with:
- The upfront income tax liability arising when gifting shares to employees;
- Possibility of future income tax charges under the restricted security legislation if no election is made;
- Helping employees who require support if they pay the tax liability through self assessment.
Changes to the articles or shareholders agreement
If the gift of shares to employees does require a change to the articles to build in protection a resolution will be required. This means shareholder consent is needed. There are filing requirements at Companies House.
HMRC reporting obligations on the gift of shares
Both employees and employers have reporting obligations.
- Employers are required to report the gift of shares to HMRC and there is a deadline to meet. Changes made to the shares held by employees must also be reported to HMRC.
- Employees have to report the gift of shares on their tax return and are responsible for paying any tax arising. Again there are deadlines.
- In practice many employers decide to help their employees calculate the tax due by agreeing the value of the shares gifted in private companies with HMRC on their behalf.
A highly experienced and practical lawyer with an additional qualification as a Chartered tax advisor, Catherine is also a regular writer and speaker for a variety of commercial organisations.