By Tom Daltry, Keystone Law
To set the potential tax issue in context; take the example of a key employee being recruited with a promise that he/she will be given a shareholding in the company. The employee’s opportunity to acquire the shares therefore arises from his/her employment. If, when the shares are acquired, they have a value greater than any amount the employee is required to pay (which may well be nil or nominal), then that difference will be treated as earnings for income tax purposes.
The problem can be all the more acute where the promise is not implemented at an early stage (when it might be that the shares have little or no value) but is only implemented after the company has grown and become more profitable.
Even though there may be no market for the shares and no exit in prospect at the time the shares are acquired, valuation methodologies can be applied to ascertain the value of a share in a private company and this will be a matter for negotiation with HM Revenue & Customs. In some cases there may be a clear indication of what that value should be; e.g. where an investor/business angel has recently acquired a small minority shareholding at a particular price. If no such indicators are present an appropriate valuation methodology will need to be identified and figures agreed with HMRC.
Employment Related Securities Legislation – Basic Scope
If a tax liability can be avoided under the general principles above, the potential for a charge under the ERS legislation must still be considered.
There are circumstances where it can be argued that the individual is acquiring shares in an entrepreneurial capacity or as a founder shareholder, rather than the opportunity to acquire the shares being offered in an employment capacity.
However, the ERS legislation includes a somewhat blunt instrument, namely a provision which says that whenever shares are acquired by someone who is, or is to, be an employee or director, they are deemed to be acquired by reason of employment. This then means that the provisions of the ERS legislation which impose (higher) income tax charges are potentially applicable.
This blunt instrument will, for example, often catch a situation in which a business angel makes an investment and is to become a non-executive director. Founder shareholders – i.e. the entrepreneurs who establish the company and who will be directors – will also typically be within the ambit of the legislation.
This does not necessarily mean that liabilities will arise under the legislation; but the potential application of the charging provisions should at least be considered. It should also be noted that the ERS legislation includes provisions which prevent an employee or director from avoiding charges by using a company or a trust to acquire the shares.
Some of the charging provisions most commonly encountered can be read about in the next article; Common Difficulties With Employment Related Securities Legislation And Shares.
This article is based on the law in force on 1 February 2012 and refers to tax rates applicable in the tax year 2011/12.
We have written these materials to help you, but no article can address all the issues. The benefit of using an experienced lawyer is that they ask the right questions and build the solution around you. Please therefore note that these materials only provide you with general information and should not be regarded as a substitute for taking legal advice.
Tom Daltry has more than 28 years of experience as a tax lawyer and was Head of Tax at Eversheds before becoming a Consultant Lawyer. He has acted for a broad range of clients, ranging from entrepreneurs and management teams to private equity houses, large PLCs/multi-nationals and financial institutions. You can contact him on 020 7152 6550 or by email at firstname.lastname@example.org
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