In this final article 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 preparing for sale.
Your business continues to grow, you are feeling pleased it is attracting the attention of potential purchasers and you are keen to get the best price for your business on any sale. It is critical at this juncture that you remain focused on day-to-day operations to ensure your business stays fit for purpose. Being proactive in dealing with tax valuation issues that arise on employee share plans will assist to reduce red flags that may arise on transaction due diligence, and could chip away at the bid price for your company.
Tackle the key issues early:
Timing is important to maximise outcome
Congratulations if your employees and management have acquired share options under one or more of the HMRC tax advantaged schemes, such as EMI. If executed correctly, in line with the rules, there should be no income tax or NIC consequences of exercise pre-completion. However, if your company and/or your employees could not qualify for these tax advantaged arrangements, your employees may have non-tax advantaged options to exercise. Notwithstanding they’ll not want to commit too early to stumping up the exercise price, they will no doubt be interested, as will you, on any tax valuation consequences of the timing of the exercise.
With few exceptions, (see below regarding “earn-outs”) an exercise at the point the deal completes will mean HMRC will ascribe a tax market value equal to the proceeds, given the certainty of the amounts involved. However, if the exercise is at a time when uncertainty still exists over price and timing, these factors can legitimately be taking into account in assessing the tax market value on exercise. While there is no ’rule of thumb’, because circumstances will differ company to company, Grant Thornton’s experience of hundreds of situations such as these, enables us to advise accordingly.
Have you left it too late?
’Sorry, we never got round to issuing you those shares we promised.’
Too late? Not necessarily. There may be alternatives to simply paying an exit-based cash bonus, which incidentally, is not tax-efficient!
On the basis that share awards are tools for incentivisation and in particular there is no guarantee that any sale will complete (the more uncertainty of outcome the better), you should not rule out a share award or grant of tax advantaged options (if you qualify) to incentivise your employees to assist you obtain the best exit for the business. It also provides you with an opportunity, even at a relatively late stage, to optimise the proceeds on any sale. So long as you do not withhold, from any valuation opinion, discussions, or communications with HMRC, the status of any discussions around a potential sale, the risks and uncertainties associated with an exit do allow for consideration of the adjustment to any value tied to potential proceeds to reflect those risks.
Importantly, you should obtain a contemporaneous valuation opinion at that point. Not only does this aid any discussions you might end up having with HMRC later, with their benefit of hindsight, but also it captures the situation at the date of the award, something that is much harder to capture later on.
What if you missed something?
’We may not have obtained a contemporaneous valuation for an earlier award.’
Not the end of the world!
At least you are closer to that date now than you will be when the prospective buyer’s due diligence team are knocking on your door. Moreover, the fact that you can present them with a valuation is evidently a benefit, as this shows you were on the ball with your employer obligations, thereby aiding the relationship and sale negotiations.
Of course, there are also non-valuation tax compliance and share plan/structuring aspects that will be on your buyer’s checklist, so you may wish to commission a review of those, given some issues that arise will take time to resolve.
It is more complicated that you may realise
‘We have the allocation of potential proceeds sorted, so can focus on other things’
This is an easy mistake to make. However, if the allocation is not on all fours with the rights embedded in your Articles of Association (in essence a core document that determines the basis of the shares tax market value) i.e. Shareholders Agreements or ‘sid’ agreements (formal or informal) in place, there is a high risk, despite the apparent ‘commerciality’ of those agreements, that income tax and NIC will be due on any excess over the proceeds that would be payable on the basis of the rights embedded in the Articles.
Our experience is that many companies that have more than one class of share do not have a full appreciation of the specific rights that accompany each class. Understandably, you may not have had to pay attention to that for many years, but we strongly recommend this issue be considered as soon as possible. This will help to avoid misunderstandings between shareholders, it will also assist to avoid the company or the shareholders being bitten by adverse tax consequences and any withholding of proceeds by a buyer, for potentially a long time, set aside to cover those consequences.
When the consideration is likely to include an earn-out element
If this is not ascertainable at the date the deal concludes, it still falls to be taxed at that point by reference to its tax market value. In essence a value that is a function of estimated proceeds (itself quite likely a function of estimated future profits) and ‘time value’. Implicitly, this value will be lower than the maximum or capped amounts due. Accordingly, it is another tax valuation matter to address early on. Not only would the shareholders welcome that but the associated tax calculations on the exit and subsequently, are not straightforward, so commissioning advice from an adviser which has the people who collaborate on these tax and tax valuation-related issues is paramount.
Finally, we hope these articles have given you a flavour of the numerous ways to operate tax efficient incentives within your business together with raising awareness of the correct ways to address tax valuation issues. We have the compass and the charts and a few decent meteorologists to aid your navigation through these waters. Just let us know where you would like to go!
Welsh businesses can make contact with Andrew Morgan Jones if they wish to discuss any of the points made in this article.