In the first of a series of three articles, Ken Read, a director in Grant Thornton’s tax valuation practice and Andrew Morgan Jones, Senior Manager in Reward Advisory based in Cardiff office, address the importance of valuations for tax purposes, over the life of a company at three key points – early life (start-up), scale up and finally at exit.
Whether you are in the process of establishing your company or an exit plan is on the horizon as part of your company strategy, the purpose of this series is to highlight how misconstrued steps taken at the establishment of your business can have adverse tax consequences on shareholder exits. This first feature focusses on important share valuation-related issues pertinent in the early life of any business with growth aspirations.
When considering the valuation of shares for tax purposes, making assumptions can be costly. Unfortunately, despite the best of intentions, all too often this is a common mistake made by business owners. These assumptions, whilst apparently logical, may well result in companies or individuals falling foul of the myriad of tax legislation, including the not always obvious interaction between tax charging provisions and tax valuation provisions, much of which is open to interpretation. This can cause significant unexpected additional tax liabilities (employee income tax and NIC at up to 47% and employer NIC at 13.8%) when shares are later disposed of after the business has grown. On an exit (e.g. sale or listing), unexpected liabilities can mean price adjustments to exit values or ‘gaps’ in the funds flow which need to be bridged. Alongside the evolution and increasing complexity of share-based incentives, there is also the challenge of staying up to speed with continually changing HMRC practice.
Be aware of the pitfalls . . .
1/ Founder shares
In the literal sense – shares acquired when establishing businesses are not by their nature exempt from the legislation that determines the income tax treatment of shares acquired “by reason of employment, or office.” – such shares are deemed to have been acquired by reason of that employment or office.
2/ Future implications
Signing up to a Shareholders’ Agreement and / or Articles of Association with “standard” provisions regarding the entitlement to pro-rata value is common-place but business owners are often surprised to find that at the point of any buy-back or transfer income tax may apply to a significant proportion of sale proceeds which is in excess of the tax market value. In a similar vein, while providing potential reward for performance, failing to embed certain rights, such as put and call options in the Articles, may mean payments are captured by the income tax legislation. These issues may have PAYE implications at both acquisition and/or disposal of the shares and therefore can create significant and unanticipated consequences for the business. Mitigating such charges is best addressed at the outset rather than waiting for the exit of a shareholder to trigger such complexities.
3/ Maximising benefits
Realisation of value from a sale of shares is evidently more attractive if subject to capital gains tax (at rates of up to 20%) with its favourable tax rates and reliefs. Yet failure to elect (within statutory deadlines) to have the shares taxed on acquisition on the “unrestricted” basis, may well eliminate a significant portion of this benefit (income tax and employee NIC rates can be as much as 47%). This is often overlooked, particularly where the shares are (reasonably) considered to have a low value on acquisition.
4/ Robust EMI planning
HMRC tax advantaged Enterprise Management Incentives (EMI) scheme are still suitable for many companies, despite the increasing number of alternative share-based incentive plans. They are particularly effective when considered at the early life stage when share values are relatively low. Given the individual scheme limit on valuation of £250,000 and the company limit of £3 million, taking advice at an early stage on EMI planning both from a commercial design and importantly tax valuation perspective is crucial to ensure the EMI plan is robust on any exit of the company.
In respect of tax structuring and valuation perspective, taking appropriate advice at an early stage should mitigate potential risks as far as possible. Consulting with the appropriate specialists, those in practice with their finger on the pulse of change and importantly offering the suite of tax valuation, share planning and associated tax advice is highly recommended. Grant Thornton can assist in these areas balancing deep tax technical knowledge with commercial and practical experience.
In the next of this three part series, we will look at tax valuation and tax related issues for scale-up businesses.
Welsh businesses can make contact with Andrew Morgan Jones if they wish to discuss any of the points made in this article.