By Tom Daltry, Keystone Law
We’ve already looked at some of the issues surrounding tax and share schemes. Some ways of addressing these issues, and additional points to consider, are as follows:
- Founders and any other employee/director shareholders who will own at least 5% of the shares should consider eligibility for entrepreneurs’ relief, with a view to securing a 10% Capital Gains Tax (CGT) rate on sale (for gains of not more than £10m – a lifetime limit for each individual). Business angels/non-executive director shareholders can consider the availability of relief under the enterprise investment scheme, potentially providing some income tax relief on money subscribed for the shares and a CGT exemption on a sale. However, in all of the above cases all or part of the benefit of these reliefs will be lost if ERS, and thus income tax charges, applies.
- Whenever possible issue shares (or consider the alternative of the grant of an Enterprise Management Incentive (EMI) option – see below) at a time when they have little or no value – do not promise an employee or director shares and then do nothing about it until after the business has acquired meaningful value.
- If shares are to be issued, the founding or controlling shareholders will wish to retain control over those shares – e.g. by requiring a departing shareholder to sell the shares back at original cost if he/she leaves employment. This issue (i.e. retaining appropriate controls over shares and avoiding difficulties with minority shareholders) can all the more easily be secured if share options are used – perhaps options which are only exercisable on an exit. If so, consideration will need to be given to the use of a form of option (e.g. an EMI option) which can avoid income tax liabilities and NICs under the ERS legislation.
- Always consider the use of EMI options for employee shareholders. If relevant conditions can be satisfied, income tax liabilities can be avoided on exercise of an EMI option, with the CGT regime applying to profits realised on a sale of the option shares. A brief overview of the conditions to be satisfied can be found below. Under certain circumstances Entrepreneurs Relief can be used with an EMI scheme.
- An alternative to EMI options is an HMRC approved share option scheme (known as a company share option plan, or CSOP). However the value of shares which can be awarded under a CSOP (£30,000) is much lower than under EMI (£120,000), the form of a CSOP is much more restrictive and there is a need to secure prior HMRC approval. EMI is almost always the preferred means of securing tax efficiency for an option.
What if there is material value in the shares at the time the share award is to be made and the employee cannot afford to pay this amount? Possible strategies include the following:
- Use of EMI options – if the price payable to exercise the option is less than the market value at the date of grant of the option, that difference will be subject to income tax and NICs on exercise, but any growth in value of the shares should be subject to the CGT regime. (Note: It would not be possible to use a CSOP in this situation since CSOP rules require that the exercise price be no less than market value at the date of grant.)
- Use of unapproved options – this avoids a tax charge at the outset (when there is no ability to sell the shares); instead the tax liabilities arise when the option is exercised, which would be timed to coincide with a situation when the shares can be sold. However, the full value at the time of exercise will be subject to income tax and NICs.
- An arrangement under which the shares are acquired at the outset with a purchase price equal to the then market value of the shares; but this is left outstanding until the shares are sold. If arrangements are put in place to protect the employee should the value of the shares go down, income tax and national insurance liabilities could become payable (e.g. on any write off of the obligation to pay the purchase price) but this may be an acceptable risk. It will be necessary to consider how to deal with leavers.
- A more sophisticated arrangement (and more aggressive and likely, therefore, to be subject to careful HMRC scrutiny and potential challenge) could be to have a special class of “flowering” or “growth” shares. The rights of these shares would be such that they arguably have little value at the outset but instead value accrues on future events, without any conversion of the shares into a different class of shares. The aim would be to enable the employee to acquire the shares for a modest market value figure, with the future growth in value being outside the charging provisions of the ERS legislation.
- Always ensure that PAYE issues are addressed through appropriate documentation. If national insurance liabilities may arise, consider whether this is a case where the law allows for the employer’s NICs to be borne by the employee and, if so, whether provision to this effect should be made in the documentation.
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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