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Gifting Shares in Family Company

I have a trading Company valued at say £750,000.  Mum (75) owns 37.5% Son 50% and employee 12.5%.  Son had inherited 37.5% from Dads estate who died in 2005, the shares were then valued at £232,500 in Dads estate.

We now want to pass 17.5% to the employee in the most tax efficent manner to ringhim to 30%.

I guess we are caught by Employment related securities legislation no matter how it is done and employee will be subject to income tax on MV(not readily convertible)

Because of the ERS tax I expect we may as well utilise Sons high base cost because of share identification rules rather than Mum paying 12K CGT on her gift.  But then we want to transfer Mums shares to Son as she is 75 wants to give him control of the company.  Mums transfer to Son would not be ERS  under the family and personal relationships but I expect she would have to hold over the gain.

Just wondering if there is anything I have missed to make it more efficent and does the company get the D1 deduction for the market value of the shares  irrespective of who gifts to the employee.

Thanks

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By Anonymous
02nd Oct 2009 15:45

Thinking of alternatives.
Could the company finance a buyback of the mothers shares rather than a gift to the son. This would then mean the employee would hold 20% of the company.

Second wouldn't holdover relief apply to the gift since the shares are business assets thereby negating any tax charge on the mother.

There are so many other options available which my reduce the tax charges. Have you considered an EMI.

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By Anonymous
02nd Oct 2009 16:12

Considered but no cash

The company is in construction, has little or no cash and, EMI still gives us the Income tax charge on exercise.  The employee could get disgruntled as he wants the shares now, which he says he was promised years ago.  I was thinking if Dads will had been varied within two years of death we may have got away with the family and personal relationships exception if the shares were bequeathed to the employee family friend. 

Too late now but is there any way a gift from Mum could be within the family and friens exception

Mum appears happy to gift all of her shares to son or a split to son and employee but it is the gift to the employee which will be attacked I fear. 

Dont suppose HMRC tend to take a gentler approach on existing shares gifted rather than the company issuing new shares under the  exception at ERSM20220.

 

Cheers

 

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02nd Oct 2009 16:56

A possible solution
I agree that the ERS rules are virtually certain to bite.

Two thoughts

1. A 17.5% shareholding is likely to be worth a lot less than 17.5% of £750k (assuming that a 100% holding is worth only £750k).

2. Who is liable to pay the income tax if the shares are given to the employee? If it is the employee himself you can say to him that he can have the shares now but he will have to find the tax or he can have options under the EMI with a nominal exercise price. That way the income tax charge is locked in at today's value but can be deferred as long as the employee does not exercise his options. If, for example, he exercises his options just prior to a sale, he will have the cash to pay the income tax.

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By Anonymous
02nd Oct 2009 17:43

Nominal exercise price ?

Interesting but does the excercise price not have to be MV at date of grant for EMI or am Imissing your point?

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02nd Oct 2009 17:51

Nominal exercise is possible
An EMI is the only type of approved share option scheme where the exercise price can be less than market value at date of grant. In such cases there is an income tax charge at date of exercise based on the difference at date of grant. See ITEPA 2003 s531.

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05th Oct 2009 11:25

I can't add much to what has been said ...
.... but it's never stopped me before!

There was a very similar query in Taxation a week or two ago, though I doubt if the replies will get you much further forward. One issue which is often overlooked is that the ERS legislation does not impose a charge on acquisition. That arises on general grounds e.g. as in Weight v Salmon and the charge is on earnings within s62. It is still possible to argue that the shares do not represent a profit or benefit from the employment, as in Hochstrasser v Mayes. HMRC do tend to argue that any receipt by an employee which he wouldn't have received if he hadn't been in the employment, is employment income. Well they would wouldn't they! Also the basis of valuation is money's worth, not open market. HMRC reckon it doesn't make much difference but it might depending upon the particular situation. There's enough tax at stake I'd have thought to get an expert valuation. David Bowes is now with Bruce Sutherland's firm and has written quite extensively on valuation of ERS.

It sounds from what you say though that there could be an argument that the shares are not acquired by reason of employment as a matter of fact, though whether you wish to 'go there' is another matter. The fact that the employee is already a shareholder may be significant. The question of whether the shares are ERS is slightly different though if it could be said that the shares are acquired in the normal course of family or personal relationships it would seem to follow that the shares were not earnings within s62. It doesn't sound as if this will apply though from what you say since if the employee is insisting on acquiring the shares I would have thought that the shares are not acquired in the normal course etc but that the employee somehow thinks he is entitled to these shares and a commercial decision has been taken to acquiesce - though that still doesn't necessarily mean that the shares are taxable as earnings. If the shares are ERS that does open a can of worms and in fact even if the acquisition is not earnings if the shares are restricted then unless a s431 election were made 100% of the value could be taxed on disposal. You could try to make the normal course argument 'look pretty' by means of a letter, minutes or deed, but there's no clearance available and so you won't know if you have succeded unless HMRC enquire into, because if you thought s431B(3)(b) applied you wouldn't complete form 42. There are thus disclosure issues re the SA return and the question of risk. As the shares do not appear to be readily convertible assets, it would appear that PAYE/NICs are not in point.

I'd explore the EMI suggestion though because even if the shares are acquired for nominal value the tax charge does not arise until exercise and is effectively frozen at the amount of the discount. Also the vendor is only taxable on the actual price - not MV (though a s165 election would be possible anyway). Of course you can't receive dividends until the option is exercised. You can agree the share value up front though, which is helpful and also if wished the options could be exercisable in the short term.

A Sch 23 CT deduction would be available for any amount taxable on the employee irrespective of who transfers the shares and since there is no cost to the company perhaps the CT relief may help to 'frank' a dividend which would help pay the tax on the shares. Has to be a qualifying trade of course.

Quite like the dilution idea, or perhaps the employee could acquire at MV but the price could be left outstanding and perhaps written off in due course which would defer the tax charge. The s178 charge would be negated as the loan would be a qualifying loan. Again would freeze the tax charge.

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By Anonymous
05th Oct 2009 20:29

Interesting Comments

Thanks for all the informative comments.

I also liked the dilution idea but it appears that in order to get  clearance cash should be paid.  The company have none.  Just had an ECR agreed and costing 60k they dont have either.  The company is in the utilities construction sector and will be profitable again.  Their contracts look good and reputation with the utility companies is strong.

One idea crossed my mind with all the EMI emphasis. As MV is not necessary and assuming no restrictions that could be the way to go bearing mind the values we are looking at.

Could EMI interact with the fact that Mum wants to gift her shares to Son in any event.  I assume we could gift and hold over if necessary.  Then issue new shares for the EMI to employee.

I did hear of an EMI scheme whereby a valuation was made of existing shares and a new class issued at a nominal value as the new shares would only share in potential proceeds above the valuation hurdle amount.  The nominal was therfore effectively market value and all the gain was CGT when the company was sold post exercise.  If that would appease the employee who would have his options and an incentive to grow the company above say a 750k valuation in order to take the excess as his own.

Everybody tells me that EMI schemes are very expensive to implement which puts small companies off. Is this true and what are the extra procedures involved which make it so costly.

Looking at the HMRC website I considered following the procedure and giving it a go.  As you can tell I  havent done one before so any experiences greatly appreciated.

 

Ken, interested if you thought that a specific legacy of a shareholding would be attacked by HMRC as ERS if it were to an existing non family shareholder/employee.

 

 

 

 

 

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06th Oct 2009 12:51

Debateable, I'd say
It is stretching the wording of the legislation to describe shares acquired under a Will as being a 'right or opportunity available by reason of the employment'. The problem is we don't really know as the legislation is largely untested by the courts. I'd also take a close look at what it says at ERSM 20220, when it talks about a "demonstrable" personal relationship. This is a question of fact. Is there a demonstrable personal relationship? Was the promise of shares a personal promise or a reward or incentive for acting as an employee? As I said there are 2 questions here really, whether the shares are ERS and whether the value is taxable as employment income. It's impossible for me to say really. The nearest decision was in Bridges v Beardsley where shares were acquired via trust by 2 directors and it was held that they were gifts or testimonials and created a more equitable distribution of the share capital, but it's a pretty old precedent. A few cases going the other way mind you.

If there is some demonstrable personal relationship with the shareholder or family then I'd have said that HMRC are not likely to argue that shares acquired by Will are ERS but then this is not a matter of immediate consequence. Whether the shares are acquired as a reward for acting as an employee is what would trigger a tax charge and really this can only be gleaned by delving closely into the circumstances. But of course even if it is considered that the shares are not earnings, HMRC may not agree. As I recall the responses to the Taxation Reader's Query weren't optimisitic based on the experience of the respondents.

I think what you are talking about are known as growth shares, so are worth nothing at present and only acquire a value if the company continues to grow. I've seen an EMI where, if the business were sold for say £10 million only the A shareholders would receive anything, if sold for £15 million the A and B shares would get half each of the excess; and if sold for £20 million or more the C shares would then share in the proceeds. You could build something like that into the articles by means of different pre-emption rights. You could give them the same voting and other rights.

Feeswise - I don't get involved in drawing up the scheme document myself but if you email me on [email protected] or via AW with your contact details I can recommend someone who would do it for £3-5k. The tax liability could be as little as about £20k though with minority discounts and in the round this would be partly offset by the CT deduction, so I'd have thought that this liability could be managed by paying the guy a bonus or div, a loan, issuing the shares for MV but nil or partly paid or a combination of ideas.

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06th Oct 2009 13:37

Just a thought
Although the buyback of shares has been discounted due to the lack of funds within the company, having thought about this further an additional concern would be the IHT position on the mother.

At the moment you have a shareholding which presumably woudl be exempt from IHT due to BPR however straight cash would be liable. Obviously I am not aware of the size of her estate but this may be a concern and as you have already mentioned she is now 75.

Another thought is that you indicated that the valuer of 37.5% was £232,000 back in 2005 but that at the moment the company is struggling in the current climate although it is likely to improve. On this basis what value would you reasonable place on the mothers holding and also on the value of the shares due to the employee which would be a minority shareholding.

If you do decide to go down the EMI route I would be able to provide the paperwork that would need to be distributed to the shareholder and to deal with the clearances that need to be obtained from the Revenue. If you would like a price please send me a private message as I suspect the price would be a guiding factor on whether the client would be willing to proceed.

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By Anonymous
11th Nov 2009 11:51

ERS?

if a client wants to give an employee 10% of the company - think they originally intended to give him 10% if he did/achieved certain things.  They have now decided that they want to sort it.

They are a trading co - they want to do it at minimal cost.  either they could gift some of their shares to him and do a holdover relief claim i guess or can issue new shares to him or even options although i guess they/he will want shares rather than options.

Can someone briefly talk me through the main tax issues on acquiring shares for nil/nominal value.  is it worth these being restricted to depress the value (obviously if not made to seem articially low etc)

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