December 18, 2023
Article
Over recent years we have seen an increased desire for employees to take a stake in their employer company and the government has encouraged this. Employee participation can take many forms and the tax legislation in this area is hedged around with complex anti-avoidance legislation. In this article, we will just look at Growth Shares and how they may be used as one example of an employee share arrangement.
The problem
Whilst many employer companies would be happy to give employee shares to some degree or another, the problem is that such a gift would be subject to income tax based on the market value of the shares. When an employee acquires shares in their employer company, there is an assumption that they are acquired by reason of the employment. That being the case, if the shares are worth more than the employee pays for them, the employee is getting remuneration equal to the difference.
Example: suppose John works for Widgets Ltd and is offered shares at £10 per share. As Widgets is a profitable company paying dividends, John is tempted to buy some. The market value of those shares is £25 per share so John will pay income tax on £15 per share when he buys them.
How growth shares work
Growth shares address the problem of an income tax charge by reducing the value of the shares being given to the employee. This can be organised in several ways, but typically the shares will have a hurdle set at the current value of the shares. This reduces the share value down to a low level and hence reduces the income tax problem.
Example: Steve works for Smith & Co Ltd and is regarded as a key person to the success of the company. The company wants to incentivise him to stay with the company so offer to give him Growth Shares. The company shares are currently worth £100 per shares so the hurdle is set at £100 per share. As a result, the current value of the growth shares is reduced to £2 per share. In five years’ time the company is sold for £500 per share. Steve will only receive £400 per share, i.e. the amount above the hurdle.
In this simple example Steve will have paid income tax on £2 per share when they are issued and will have a capital gain of £398 per share on sale.
That sounds too simple…
This article is a little too simple, but space does not permit us to be able to fully discuss the concept of Growth Shares. Suffice to say, that great care is required to ensure that the desired result is achieved. The restricted securities legislation must be considered to ensure the tax treatment is as expected. Also, the terms of the Growth Shares in the context of the company will affect the valuation of the shares so robust valuation advice is normally advisable.
In summary: Growth Shares can be a useful tool to incentivise employees to remain with the company and participate in its growth in value in a tax efficient way, particularly where EMI option schemes are not available.
If you would like further information or advice on this subject, please contact me or your usual Albert Goodman contact.