Gifting or rewarding of shares is good source of motivation and helps employees to participate in the growth of the company. Shares can be rewarded to employees for remuneration of services, as a performance incentive or to retain talented employees. Proper planning is very necessary for an employer before issuing shares to their employees as a gift or a reward. As an employer, you should setup a right structure for your employees and directors before offering them shares as a gift.
- Structuring shares for employees
- Restricting employee shares to protect shareholders from risks
- Tax issues on gifting shares
- Implementation of gifting of shares
- HMRC reporting obligations
Structuring shares for employees
As per the statistics, it is seen that companies that issue shares to employees as a gift performs better as well as earn more profits than others. Shares gifted to employees by reason of employment are treated as taxable employment income, while the organic growth in the value of the shares will be subject to the more generous Capital Gains Tax (CGT) regime.
So, when the shares are gifted to employees, the market value of the shares at the date of the gift will be subject to taxable employment income and any upliftment in the value of the shares on disposal will be subject to CGT.
Therefore, it is important for employers to structure the gift of shares tax efficiently so the profits made on the sale or transfer of the gifted shares can besubject to capital treatment in comparison to the much higher rates of income tax and NIC.
How can employers provide shares to employees as a gift?
There are generally two ways by which shares can be provided to the employees as a gift
- Transferring shares owned by existing shareholders.
- Issuing new shares.
Gifting existing shares to employees
In the case of existing shares, some proportion of shares that are held by the existing shareholderscan be transferred to employees after agreeing upon the same. The gift of shares will be treated as disposal at market value for CGT purposes and the shareholders will be subject to CGT. Since, there is no consideration received for the shares, there is no stamp duty payable on transfer. The key benefit of giving existing shares is that there is no dilution for other shareholders.
Issuing new shares
Instead of giving existing shares, employees can be issued new shares in the company. The benefitsof issuing new shares are as follows -
- The rights of the shares can be varied.
- No capital gains tax charge for the existing shareholders.
The main disadvantage of issuing new shares is the shares of existing shareholders are diluted. There is a possibility that you can limit the dilution to specific shareholders. However, in case existing shareholders are caught by anti-tax avoidance value shifting provisions, limiting the dilution can raise the tax charge for their existing shareholders.Hence, newly issued shares are generally preferred over transferring of existing shares.
Restricting employee shares to protect shareholders from risks
Gifted shares are retained by the employees when they leave the company. Hence, ex-employees continue tobenefit by these gifted shares when the company grows. An exit can be stalled even by the ex-employers by refusing the selling of shares. Provisions must be included in the company’s article of association and the shareholder’s agreement.
Retaining the ability to exit
In case the company is sold, any employee holding shares will be treated like any other shareholder. Kindly make sure that article comprises of appropriate drag along rights so that other shareholders can be protected from the risk of employees non-selling of shares. A business may be unsaleable without giving drag along rights to other shareholders.
Good and bad leavers
Whenever an employee leaves an organisation, it is distinguished either being a good or a bad leaver. Good leavers are those employees who leaves the organisation because of death, disability or when the director want them to continue their services for the company growth. Bad leavers are those employees who left the organisation because of factors like underperformance or when the director does not want them to continue their services for the company growth.
Limiting the rights of the shares
Employer must give preference and deal with restrictions before gifting/rewarding shares to their employees as it is needed for tax purposes.
For ex – Restriction on voting rights. These restrictions are generally dealt with via articles amendment. This is done as lifting of restrictions can cause unexpected and unforeseen tax liabilities when employee becomes a shareholder.
Also See: Taxes on Stocks and Shares in UK
Tax issues on gifting shares
You need to be very cautions while gifting shares to your employees. Gifting shares to employees looks simple but it can be extremely complex due to arising of unexpected and unplanned tax liabilities. HMRC holds some really hard anti-avoidance legislation on gifting of shares. Tax needs to be considered in the following cases –
- Gifting of shares
- Once the shares are gifted, rights are varied in any way.
- Sale or transfer of shares by employees
- Other issues
Basic tax rules on gift of shares
When an employer gifts shares to an employee, it is considered as taxable employment income and the exact tax treatment will depend on whether the shares are classed as readily convertible assets (RCA) or not.
Shares will be considered as RCA if they can be easily converted into cash for example can be sold on stock market, the employer makes arrangement for the shares to be sold when they are acquired by the employee etc.
If the shares are RCA, the employer is required to operate PAYE and pay tax and class 1 national insurance contributions on the market value of the shares at the date of the gift. The tax will be due by 22nd following the end of the tax month if paying electronically or by 19th. The employer is then required to recover the tax paid from the employee no later than 90 days after the end of the tax year in which the shares were gifted.
If the shares are not RCA, the employee will need to report this in their self-assessment tax return and pay tax on it.
The company gifting the shares will receive corporation tax deduction provided the shares gifted are ordinary shares with no special rights and it is not under the control of another company.
Employers who are gifting shares to their employees that are making profits should consider that how employees will settle their tax liability arising from the gifting of shares.
Use of bonus is one option which covers the tax liability of employees. Bonus payments attract income tax and NIC which an employer can use to reduce their corporation tax bill.
Change in the rights of gifted shares
Changing of rights in relation to shares that leads to inflation in the value of the employees shares after the initial gift and tax payment on award can lead to further tax changes. It can also mean that some of the profits on selling or transferring of shares are subject to Income Tax and NIC rather than lower rate of capital gains tax. Risk can be eliminated by many ways which the employer must explain to employers.
Sale or transfer of gifted shares
The main intention or motive behind selling or transferring of gifted shares is that employee should gain from selling or transferring of shares and that gain is subject to capital gains tax. It is desired as the rate of capital gains tax on equivalent profits is much lower than the rate of income tax & NIC. In case the employee meets the condition, they will get the benefit of business asset disposal relief or entrepreneur’s relief which helps in decreasing the capital gain tax rate from 20% to 10%.
A company can also buy back the shares from their employees like any other shareholder. Employee can be eligible for tax beneficial treatment in case of buy-back of shares.
Valuation of shares gifted to an employee
When an employer gifts share to the employees in private companies, it requires share valuation. The main motive behind share valuation is to calculate the amount of tax to be paid on gift. It can be complex to do valuation of shares in case there is no ready market for tax purposes. However, the tax amount payable by the director or employee on gifting of shares will hang on the valuation HMRC places on assumed BIK. It is therefore advisable that employersagree the valuation with HMRC’s Share Asset Valuation department before issuing the shares.
Dividends paid to employees
Dividends are considered more tax efficient than salary as it is taxed at lower rates and not subject to Class 1 NIC.
Employer can face tax issues in case HMRC identifies that employer has paid employees dividends in lieuof salary. Therefore, employer must arrive at any decision in consultation with other board members and the dividends paid to employees must be on a commercial basis and reasonable. There are strict disguised remuneration rules, which if imposed by HMRC will lead to decrease in tax advantage of receiving dividends.
Implementation of gifting of shares
There are many things which an employer needs to consider while gifting shares to their employees. Number of steps includes
a)Which is the better alternative of gifting shares to employees?
There are many options available with the employer to gift shares to their employees. The employers can make use of the four types of tax advantaged scheme – Save As You Earn (SAYE), Share Incentive Plan (SIPs), Company Share Option Plans (CSOPs) or Enterprise Management Incentive (EMI). Many of the companies give preference to EMI, as it is flexible as well as tax efficient but in case it is not find suitable or attractive, other alternatives can be considered for the same.
b)Recording of gifting of shares
The details of gifted shares must be recorded by the employer when they are gifted and reported to HMRC under the restricted securities regime. It is important to record the details of gifted shares to employees as it deals with the following –
- Income tax liability arises when an employer gifts share to their employees.
- It might be possible that you incur future income tax charges if no election is made.
- To provide required support to employees in case payment of tax liability is done by them through self-assessment.
c)Changes to the article or shareholders agreement
There is a need of passing a resolution, if the changes made to articles or shareholders agreement is a requirement in gifting of shares to employees. It is to be done with the consent of shareholder. Fulfilling of companies house requirements is also necessary.
Also See: Entrepreneurs Relief When Selling Shares
HMRC reporting obligations
It is necessary for both employees and employers to fulfilthe reporting obligations of HMRC. Following reporting obligations to be fulfilled
- Employers need to report the gifting of shares to HMRC under the restricted securities regime before the deadline, i.e. by 6th July following the year in which the shares are issued. Any changes made to the employee’s holding of shares must also be reported to HMRC.
- Employees also need to report the gifting of shares on their tax return and are responsible for the payment of taxes to HMRC before the deadlines.
- Many of the employers of private companies help their employees in calculating the due taxes by agreeing to the gifted shares value with HMRC on their behalf.
Although gifting of shares to employees is beneficial for the purposes of retaining and motivating employees, the underlying tax liability for the employees can be a significant disadvantage and hence it is recommended that employers seek professional advice when structuring the shares.
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