How to avoid tax problems with share awards

Helping private companies work this out is a core area of our expertise.

Typical ways we advise and assist clients include :-

• Advising on the complex tax rules as part of your planning stage
• HMRC procedures - 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.
• HMRC and Inland Revenue Enquiries - our specialist solicitors are able to assist with HMRC and Inland Revenue enquiries and investigations. Usually enquiries are concluded quickly through correspondence. However, HMRC can choose to look into your finances.
• Communications with employees - 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.

Please do call us to discuss your position.  We are always happy to provide a scope of work and estimate.

When does tax arise if shares are provided to employees?

Tax can arise on award, exercise and sale of shares provided by the employer.  Taxable events include:

• Exercise of options;
• Gift of shares; and
• If share rights are enhanced.

Basic rules

The basic tax rule is that if the employee or director is given shares for free or pays less than the market value of the shares at the time of award a charge to income tax and sometimes national insurance will arise. The tax charge will be the difference between market value and the price paid by the employee.  In most private companies the market value is unknown as the shares are not traded.  HMRC will provide a determination on market value but only after the issue or transfer of shares has been made.

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 of tax paid on acquisition.

Working out 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. Differences can apply with :-

• Start-up companies - HMRC will accept that start ups have limited assets, and no trading history. The market value of the shares is usually agreed by HMRC to be low.
• Where there have been investment rounds - if the start up has received investment, such as a SEIS Investment 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.
• Discounts can be applied before reaching the taxable value of unquoted shares - such as restrictions set out in the articles or shareholders agreement about how an employee or director transfers his or her shares to the company and or other shareholders on leaving employment or imposition of hurdles often seen in growth shares which have to be achieved before rights arise or a discount to the taxable value for a minority shareholding. The discounts have to be negotiated and agreed with HMRC on a case by case basis.