What happens with employee shares when a business is sold.

We deal with a significant number of business sale transactions each year and have specialist tax expertise alongside our corporate experience, which can be particularly valuable when dealing with employee share arrangements. We would be happy to discuss your business sale with you and provide practical, specialist legal advice. Please do call or email.

If you are preparing to sell your company or are already negotiating with a potential purchaser, tax is likely to be one of your key considerations. If your business has employee shareholders, you will also want to ensure they understand and support the proposed sale, making the tax treatment of their shares an important consideration.

Generally, you will want to ensure that you achieve the best capital gains tax treatment available on the sale of your shares, including on any earn-out or other deferred consideration. The tax position can be complex, particularly where the employment-related securities rules apply. If the legislation is not dealt with correctly, amounts that you expect to receive capital treatment may instead be treated as employment income, potentially resulting in a significantly higher tax liability. We do see clients get caught out.

Corporation tax (CT) relief on the exercise of share options

UK corporation tax relief may be available when employees acquire shares through the exercise of qualifying share options. With corporation tax rates having increased, this can represent a valuable relief for companies to consider as part of an exit. However, not all sellers realise that this relief may be available, potentially to their cost. HMRC guidance confirms that statutory relief can apply to shares acquired by employees through share options, subject to the relevant qualifying conditions.

For example - unapproved options:

• 10 employees and directors are granted 100 unapproved options each.
• On exit the shares are worth £500 each.
• There is no cash outlay required from the employees or directors.

On the exit sale of the company, the employees and directors will have to pay income tax and potentially National Insurance contributions on the value of the shares – i.e. 100 x £500 = £50,000 individually or £500,000 for the 10 employees and directors combined.

Where the statutory conditions are met, the company may be entitled to a corporation tax deduction reflecting the taxable amount arising when employees acquire the shares. The precise amount of relief will depend on the circumstances and the relevant statutory rules.

For sellers, it is a case of considering the available relief early where corporation tax relief and share options are concerned. It is too often the case that a seller will miss the opportunity to factor this valuable relief into negotiations with a buyer. On other occasions, sellers may only become aware of it too late in the exit process and therefore lose the opportunity to reflect the benefit of the relief in the sale price or through other arrangements.

Option exercise prices can also be significant, and sellers should ensure that they are appropriately reflected in the purchase price, particularly where the aggregate exercise prices are substantial.

Restricted shares and section 431 elections

Many directors or employees will acquire shares in their employer company, or another company in the group, subject to restrictions. The effect of these restrictions can be to reduce the initial taxable value of the shares acquired by the individual. However, without appropriate planning, part of the growth in value may subsequently be subject to employment income tax and PAYE/NIC rather than capital gains tax.

Example

• Say the unrestricted market value of a share is £12, but due to restrictions on the sale and transfer of shares, the value of the shares is £9 on acquisition.
• The employee paid £9 per share.
• If the restrictions remain in place, the employment-related securities rules may result in part of the subsequent increase in value being taxed as employment income. On a later sale at £40 per share, the precise tax treatment will depend on the restrictions and the steps taken when the shares were acquired.
• However, there is a choice. If the employee had entered into a section 431 election with their employer to disapply the restrictions at the time of acquiring the shares, the employee would have been taxed upfront by reference to the unrestricted market value. This can mean that subsequent growth in value is subject to capital gains tax rather than employment income tax.

The election must be made jointly by the employee and employer within 14 days of the acquisition or relevant chargeable event and in the form approved by HMRC.

If an election has not been made within 14 days, the position needs to be considered carefully in light of the particular restrictions and circumstances. In some cases, it may be possible to remove or ‘lift’ restrictions and make an election in respect of the remaining restrictions, but the tax consequences need to be considered before taking any steps.

Early tax planning can therefore be important. Understanding how employee share arrangements will be treated before a sale is negotiated can help avoid unexpected tax liabilities and ensure that the benefit of available reliefs is properly reflected in the transaction.