Discovering that you are being investigated by HMRC can be very stressful, even if you are...
Many companies opt to reward their employees with shares or options because of the manifold benefits to both parties. With a greater commitment to success and heightened engagement, share ownership delivers considerable rewards for both employer and employee.
However, one of the issues that must be considered is taxation. When the company is sold or shares are surrendered, the issue of taxation will arise. What many do not realise is that taxation on private company shares may be a factor at other times, and not just the point of sale.
Here is an overview of how private company shares are treated for tax purposes, with all the essential facts you need to know.
When Will A Tax Charge Arise?
Tax charges are something that every business needs to factor in, and the obvious time is when a sale occurs. This fixes the price of the shares and makes it easier to calculate what the tax liability will be.
But a tax charge can arise at other times, and not just when a private company is sold. These could include:
- When EMI options (or other share options) are exercised
- When a shareholder is bought out
- When new shares are issued in lieu of other remuneration
- When existing shares are transferred to employees as part of a share scheme
- When the terms of shares are altered, providing additional benefits, thereby increasing the value of the shares
- When shares are gifted to any individual, for any reason
If any of the above situations occur, it is essential to consider whether a tax charge may have arisen. The difficulty is that it is not as easy to calculate potential liability without a firm sale price, or public market conditions.
The tax charge calculation is further complicated by the fact that the value can be assessed differently, depending on the conditions. You will need professional services from an accountant to ascertain the correct calculations, as HMRC have very strict guidelines about what values should be used for each purpose.
What Does HMRC Say?
There are different approaches that can be adopted when calculating the value of shares, with each one more appropriate in certain circumstances. However, HMRC also has its own ideas about how shares should be valued for their purposes.
There are no hard and fast rules which apply universally, but the following factors could all be taken into account by HMRC when considering whether the right value is being used:
The size of the shareholding is relevant in terms of whether it could impact on the decisions being made by the company. A discount will normally be applied to the full market value of a smaller percentage holding in a business.
Any voting rights
Voting rights are a very fundamental factor for HMRC and they will consider the influence that shareholders have over business operations. This could include the sale of assets, how shares are distributed and overall management of the business. If shareholders have persuasive voting rights, they will have greater ability to potentially manipulate the price to suit their agenda.
In particular, HMRC will be interested whether a majority shareholder has control over the company or whether their opinion could be cancelled out. Any shareholder holding 50.01% or more is assumed to have control. As part of this, any shareholders who are linked will also be taken into account. This is because it may be assumed that their percentage will be combined to give them extra sway in voting.
Influence over director appointments
The subject of control and influence arises again when considering whether shareholders can appoint a director to the board. If they have this right, there is greater influence over board meetings and director meetings. Few minority shareholders are able to have any input into the appointment of a director unless they are a board member already themselves.
Power of the veto
If any shareholder has voting rights of 25% or more it is common for them to be able to enact a veto. This means that certain decisions from majority shareholders may be blocked. If it is written into the articles of association or if there is a shareholders’ agreement it is possible to grant the power of veto to shareholders who have less than 25%.
Shareholders Agreement and Articles of Association
These documents may contain clauses which have a bearing on the taxable value of the shares. Many of these pertain to the rights of shareholders and their influence on decisions.
How to Calculate the Taxable Value
The above factors will be considered as potentially relevant by HMRC when assessing the correct taxable value and resulting liability. When making your own assessment there are three different types of valuation basis which could be used:
It is very common to use the earnings basis for the purposes of valuation, especially when a business is about to be sold. This calculation considers the potential future profits which may be generated before dividends, tax and interest have been paid. This figure is known as maintainable profits or EBITDA.
This method is typically used where a single shareholder has control over the business, or where a valuation of a majority shareholding is required.
In the cases where one of the main advantages to being a shareholder is the payment of dividends, it is appropriate to use the dividend valuation basis. It is useful for established businesses with minority shareholders and uses the past performance of dividends to provide an indication of future dividend policy.
A dividend basis will not be suitable for every type of business; those still in investment mode or not yet generating a profit should use alternative methods. It will also only work for businesses where the shares generate a dividend payment.
The third and final basis for valuation is the asset calculation. This can be used when earnings are less likely to be paid out to shareholders but instead reinvested in the asset base for equipment, stock, long term or short term assets which will produce revenue or grow in value over time, or when a company is being liquidated. It is not unusual for property companies, or other asset heavy companies, to use an asset basis for their calculations.
Whichever process you use for calculating the taxable value of your shares, make sure that you do not miss any chargeable events and seek the advice of a professional to advise the most appropriate option.