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Partly paid shares give employees an interest in the company
by Stephen Deutsch
This article was originally written for issue 25 of "Talking Tax" the tax newsletter for the UK200 Group.
"Partly Paid Shares will give employees an interest in the
company" explains Stephen Deutsch, Senior Tax
Consultant BKL London and member of UK200Group Tax
Panel
One common method of allowing employees to acquire shares is to grant him or her an option to purchase shares at a future date but at a price determined when the option is granted. Should the various tax friendly ‘approved’ share options schemes not be available the employer could grant options under an unapproved share option arrangements. However, such arrangements are generally unattractive because of the income tax and National Insurance liabilities that arise on the gain on their exercise.
A possible alternative is the use of partly paid shares, which will give the employee an interest in the company. Like options, this can avoid a substantial initial financial commitment.
For example, the current market value of the shares in the company is £1 per share, but, for whatever reason, it is not practical for the employee to subscribe this amount. Instead, he subscribes for shares at £1, but with only 20p per share paid. The employee would pay the remaining 80 pence per share if the company were a commercial success and the sum due might be settled prior to a sale of the company.
From a practical perspective, however, it must be remembered that an employee can usually be required to pay up the unpaid amount in respect of partly paid shares. By contrast, he can never be obliged to exercise an option. However, if the company is not a success, it may be possible in some circumstances, and subject to detailed legal advice, for its Articles to provide for the shares to be forfeited in the event of the employee being unable or unwilling to pay a call by the company of the remaining unpaid amount.
Of course, the success of all share incentive schemes is always dependent on whether or not it achieves the company’s commercial objectives. These should be paramount, and the tax consequences must be secondary to these. Nevertheless, there are some significant tax implications in using partly paid shares and these are now summarised:
Tax Considerations of partly paid shares
1. PAYE & NIC
Partly paid shares are deemed to be readily convertible assets and PAYE/NIC will be payable where transactions involving these shares are taxable as employment income.
2. Restrictions on the shares
If the shares are ‘restricted’ shares, (for example, bad leaver restrictions may be thought necessary) restricted and unrestricted values should be established and consideration be given to the implications of the restricted security regime. This will include the possibility of the employee being required to pay the full unrestricted value of the shares or if acquired at below that value, electing to be taxed on the full unrestricted market value on initial acquisition under ITEPA 2003, s 431. This is important not only for the employee, but also for the company as any income tax charge will have PAYE and Class 1 NIC implications. Many arrangements make the signing of such an election a requirement.
3. Notional Loan
The employee will be subject to income tax on the benefit of a ‘notional loan’ of the remaining amount outstanding on the shares. This is an annual charge at the official rate of interest, currently 5%, calculated on the outstanding amount. The employer will also have to account for Class 1A NIC. However, there is no income tax charge where the beneficial loan exemptions apply. If the company is close and the employee is involved in the actual management of the company (or has an interest in more than 5% of the share capital), there will be no tax charge.
4. Forfeiture of the shares
Let us assume that the company is not successful and the shares are forfeited. The notional loan (see above) will be treated as written off, and the employee will be liable to tax on the notional loan. In the example above, this would be tax on 80p per share. This is an entirely different proposition for the employee who is subject to tax under an option arrangement because he or she gets a charge to tax without any income to pay for it.
5. Capital gains tax
On disposal, taper relief will run from the date of the acquisition of the shares, not the dates upon which calls are made.
6. Corporation tax
Corporation tax relief is, in some circumstances, available for an amount by which the market value of shares provided to employees exceeds the amount paid by them. However, where shares are not fully paid on issue, the company is specifically debarred from claiming a corporation tax deduction.
7. Section 419
If the issue provides for an immediate call on the whole issue value, but with agreement to delay part of that call there will be a deemed loan for the purposes of s419 and therefore a potential tax charge.
However, if the issue is £1 paid and the balance to be called at yearly intervals over, say, a five-year period or left uncalled there is no immediate debt as the debt only arises on the call, and hence, no s419 liability."
