How to avoid tax problems with share awards

Helping private companies understand and manage the tax implications of employee and director share schemes is a core area of our expertise.

Typical ways we advise and assist clients include:

• Tax planning – advising on the complex tax rules affecting share awards and options, helping you identify potential liabilities and plan for them at an early stage.
• HMRC procedures – advising on elections and other formalities that may be needed to secure the intended tax treatment. In some circumstances, a joint election is required to transfer the employer’s liability for certain National Insurance contributions to the employee. The appropriate treatment depends on the type of award and the circumstances. Failure to meet the relevant requirements can result in unexpected tax liabilities and penalties. HMRC penalties depend on factors including the nature of the failure and the taxpayer’s behaviour. Taking appropriate advice and maintaining accurate records can help demonstrate that reasonable care has been taken.
• HMRC enquiries and investigations – assisting with HMRC enquiries concerning share schemes, valuations and employee tax liabilities. Many matters can be addressed through correspondence, although the scope and duration of an enquiry will depend on the issues raised.
• Communications with employees – explaining the tax and valuation implications of share schemes in clear, accessible language. Employees often need to understand the distinction between Income Tax and Capital Gains Tax, the potential tax bill and their reporting obligations.

Contact us to discuss your circumstances. We can provide a tailored scope of work and fee estimate.

When does tax arise if shares are provided to employees?

Tax may arise at different stages, depending on the type of award, the terms of the scheme and the circumstances. Potential taxable events include:

• Exercise of share options.
• Gifts or other acquisitions of shares at an undervalue.
• Changes to share rights or option terms that give rise to a taxable benefit.
• Sale or disposal of shares, which may trigger Capital Gains Tax.

Basic rules

Where an employee or director acquires shares for free or pays less than their taxable market value, an Income Tax charge may arise on the employment-related benefit. National Insurance contributions may also be due, depending on the circumstances. The amount chargeable will generally depend on the relevant market value, the price paid and any applicable exemptions or reliefs.

For most private companies, there is no readily available market price because the shares are not publicly traded. HMRC may agree or determine a valuation for tax purposes, but the process and timing depend on the relevant scheme and circumstances. Obtaining an appropriate valuation before shares are awarded or options are exercised can help manage the risk of unexpected tax liabilities.

Decrease in value of the unquoted shares

If shares fall in value after an employee has acquired them, the original Income Tax liability will not generally be recalculated simply because the shares subsequently decline in value. This makes it important to assess the potential tax exposure before the award or acquisition takes place.

Similarly, if an employee is required to transfer shares for a nominal amount under good leaver or bad leaver provisions, the tax consequences of the original acquisition will not automatically be reversed. The position depends on the terms of the arrangement and the applicable tax rules.

Working out market value

Different businesses require different valuation approaches. There is no single methodology for share valuation. HMRC valuation principles generally consider the price that might reasonably be obtained in an open-market transaction, applying the relevant statutory rules and assumptions. The rights attached to the shares, the circumstances of the transaction and any restrictions may all be relevant.

• Start-up companies – early-stage businesses may have limited assets, little or no trading history and uncertain future prospects. These factors can affect the valuation, but a low valuation is not automatic and must be supported by the available evidence.
• Companies that have raised investment – previous investment rounds, including SEIS investments or EIS investments, are relevant to a valuation. HMRC will generally need information about the investment terms and the rights attached to the shares issued. The price paid by investors may not be directly comparable with the value of shares awarded to employees, particularly where different rights apply.
• Established trading companies – valuing shares in an established business may require consideration of earnings, assets, forecasts, sector conditions and other relevant factors. The appropriate methodology depends on the company and the rights attached to the shares.
• Discounts and restrictions – restrictions in the articles or shareholders’ agreement, compulsory transfer provisions, growth-share hurdles and minority shareholdings may affect the valuation. Whether and to what extent these factors reduce the taxable value depends on the applicable valuation rules and the facts. Any proposed discount should be properly evidenced and, where appropriate, discussed with HMRC.