In this second of three articles on the importance of valuations for tax purposes, Ken Read, a director in Grant Thornton’s tax valuation practice and Andrew Morgan Jones, Senior Manager in Reward Advisory based in Cardiff office, consider tax-valuation and tax-related issues for businesses scaling-up.
Great news – the business is doing well. You are clear on the direction you wish to take and where to focus your efforts. You have a business plan and the desire to execute it. You have the funds lined up, identified new people to join you on your journey and you are confident that your existing people will come along with you, suitably incentivised.
Our experience proves that addressing tax valuation and tax-related issues in the correct way can be key to achieving your aims and objectives.
Be aware of the opportunities, as well as the pitfalls!
Do you want to give shares to your team?
You are considering issuing shares to employees and management. Any shares or share options issued to employees and management or directors who are not employed will be deemed to be by reason of their employment and are likely to have PAYE and employer reporting implications. If your prime consideration is making this attractive to them, you may well be able to take advantage of the tax basis of valuation, which normally allows significant discounts to the pro-rata value to cater for the characteristics of shares issued by private companies. Importantly HMRC accept these principles apply and we can help you understand the extent of that advantage.
Avoid expensive mistakes
Even with such discounts available, as the business is doing well, the shares may still appear “expensive”, to an employee, particularly if there is no short-term opportunity to exit or realise value (e.g. on a sale of the company). You may also not be paying dividends, as you reinvest your profits to grow your business. One way of addressing the cost of investment by the employee is to create a type of share, known as a “growth-share” that only participates in value or proceeds on achievement of certain financial performance or valuation hurdles. Implicitly these shares have a lower initial value – as they only participate in the growth of the value of the company – thus lowering income tax charges at acquisition and subject to certain conditions, can be used with the highly tax-efficient Enterprise Management Incentives (‘EMI’) Scheme or, if you have outgrown EMI, a simple up-front acquisition of shares. The key to a successful implementation of growth shares is to carefully consider the rights and restrictions that attach to these shares at the outset, and how these are documented. How they are documented will also impact the tax valuation. As it is not possible to get HMRC agreement on valuation, taking professional advice is essential, to achieve PAYE compliance at acquisition and avoid unintended consequences when the shares are latterly sold.
Knowing this might help you make the right decision at the outset
Further down the line, these shareholders may be looking for some realisation of value or if leaving the business have some expectation of proceeds for their shares. Naturally, they assume they would receive the pro-rata value, subject to share class rights. However, the minority value (which favoured you and the employee at acquisition, to manage the up-front cost) is highly likely to be the market value for tax purposes, the difference between that and the proceeds is then subject to income tax and NIC (at rates of up to 47%), with PAYE implications. Naturally, this can leave a sour taste and complicate negotiations for the departure of an employee shareholder. Whilst there are ways of mitigating this, a full understanding of the potential for adverse tax consequences should be a key consideration on day one.
Grant Thornton’s experience will help you navigate the issues highlighted in this article together with providing help and support with any tax-valuation related aspects, associated with fund-raising and incentivising your people.
Welsh businesses can make contact with Andrew Morgan Jones if they wish to discuss any of the points made in this article.