Giving an employee shares? Make sure you understand the tax implications

This post is part of our Entrepreneurial team’s regular series of blogs.

Gifting an employee shares in a company is often used to incentivise and reward key employees within a business. However, doing so may result in the employee being liable to pay income tax on the award.

This is because where shares are simply issued or transferred to employees for no consideration, or for less than their market value, the employee will be subject to income tax on the market value of the shares less what they paid for them.

There could also be capital gains tax or inheritance tax implications for you as the person making the gift.

Consider whether there is a more tax efficient way to do it…

There are lots of different mechanisms through which you can get shares into the hands of your employees. These include through tax-advantaged schemes such as EMI and HMRC-approved CSOP schemes, as well as through unapproved option schemes which, while less tax efficient, provide more flexibility. Bear in mind that EMI options can be granted by individuals who hold shares (as well as by the companies), and that – wherever possible – EMI tax benefits mean it is worthwhile trying to use this route if you can.

Ultimately, a simple, outright gift of shares may be the best route for you, but before you jump into gifting shares you should be aware of the tax consequences for both parties and consider whether there might be a better way to achieve your aims. We recommend speaking to a tax advisor to create a solution that’s right for your company and your employees.

Know what your shares are worth

We would recommend that you have a share valuation undertaken in order to determine what the market value of your shares are so that you know what the tax charges will be in advance of transferring the shares. We can assist with this.

Consider a section 431 election

If you do go down the route of the employee immediately acquiring shares (as opposed to an option), consider s.431 elections – these are very often desirable to save on income tax. Often private companies’ shares are ‘restricted securities’ for tax purposes due to restrictions on their disposal, within the company’s Articles, which affect the value of the shares. Where these restrictions exist an election, known as a s.431 election, can be entered into jointly by the employer and employee within 14 days of the acquisition.

This election opts the recipient of the shares out of the restricted securities taxing regime. As a result, the employee will have a higher income tax charge on the acquisition as it is calculated on the higher unrestricted market value of the shares (which ignores the restrictions that apply to the shares) BUT on the eventual disposal of the shares the employee will only be subject to capital gains tax – no further income tax under the restricted securities regime will arise.

Where no s.431 election is entered into, a further income tax charge will arise on a “chargeable event” – such as where restrictions are lifted or the shares are sold on to a third party. Usually it is in the individual’s favour to enter a s 431 election to avoid such further income tax charges. It can also save the company the cost of employer’s NICs, as explained below.

Does the income tax need to be paid via PAYE?

If your shares are considered to be a readily convertible asset (RCA), either by being capable of being sold on a market (such as the London Stock Exchange) or through other trading arrangements being in existence (such as an exit being about to happen), income tax due will be charged via PAYE with Class 1 employers and employees National Insurance contributions also being due. Class 1 NIC is currently paid by employers at 13.8% (on top of the employee contribution). This can, therefore, add up to a significant additional tax charge; assuming the employee is a higher rate tax payer this would result in an overall tax charge of over 55%. Further, the employer’s NIC may be an unexpected cost to the company.

Where the shares are not considered to be RCAs then income tax is payable via the individual’s self-assessment tax return, and NICs are not relevant.

Be aware that whilst the shares may not be an RCA at the time of acquisition (gifting), they could be RCAs when the individual comes to sell them e.g. if they are sold on an exit where there is a buyer in place for the company’s entire share capital. This would mean that if a section 431 election had not been entered into, the further income tax charge arising on disposal of the shares would be payable via PAYE and the employer’s NICs would represent a cost to the company.

Know your annual reporting obligations

Where an employee (or director) has acquired shares in the company it has an obligation to report this acquisition to HMRC via an annual Employment Related Securities (ERS) return. This should be submitted to HMRC by 6 July following the end of the tax year. We can assist with this.

What if the employee leaves?

We would recommend speaking to your lawyer to make sure you’ve got the right provisions in place in your Articles of Association to deal with what should happen to the employee’s shares if they leave the company. Would you want an obligation on the individual to sell the shares back or not and, if so, at what price?

To gift or not to gift?

Ultimately, whilst gifting shares to employees is often viewed as a simple matter, doing so can give rise to tax liabilities as well as reporting obligations. While this blog provides general advice on some points to be aware of, you should always seek tax advice specific to your own circumstances before gifting shares.

We would be happy to assist you with this. If you are considering gifting shares to your employees or granting them options over shares, please contact us.