Chistmas giving Part 2. By Nichola Ross Martin

Nichola Ross Martin, of the looks at PAYE settlement agreements and how to gift private company shares this Christmas...

Jim Shaw, who (ignoring all best practice in corporate governance), is both chairman and CEO of Aardvark Enterprises Limited (AEL) decided to gift his long serving secretary, Debs, some shares for Christmas.

The shares in AEL are only subject to income tax in her hands, because they are not readily convertible assets, but Jim thinks it only fair if the company picks up her tax tab. He also needs a bit of advice on the tax treatment of her dividends.

PAYE settlement agreement

AEL can pay Deb’s tax under a PAYE settlement agreement. The tax liability then becomes the company's alone, and the amount of tax paid is determined by an agreement between it and HM Revenue and Customs (HMRC).

The PSA works on the basis that the gift is an "irregular" benefit. HMRC's guidance on PSAs comments at one point that they do not allow PSAs to cover shares, because of the complexities involved in employee share taxation. However, a general earnings charge on a gift of shares is not complex and long service awards are certainly something that can be covered. It seems likely that this comment is directed at the more complex tax charges on employee shares, not a case like this.

Calculating the tax and NICs to be paid

AEL will have to "gross-up" the tax figure, that is work out the tax due on the overall benefit of the shares plus the tax. Assuming that the gift (and associated tax benefit) will still leave Debs as a basic rate taxpayer, the total tax and NICs payment can be estimated as follows:

Apply long service award exemption:
Taxable value = £10,000 - £1,250 = £8,750

Calculate the tax the employee would pay on this basis (ie, without AEL meeting the tax liability):
£8,750 @ 20% = £1,750

Gross up the income tax (at 20%):
(£1,750 x 100)/(100 - 20) = £2,187.50

Calculate NICs (only tax on the benefit of tax paid will be subject to NICs - if the shares are not readily convertible assets, the value of the shares will not be):
NICable value = £2,187.50
Under a PSA, NICs is payable by AEL as class 1B NICs at the rate of 12.8%.
Therefore, NICs = £2,187.50 x 12.8% = £280

Total grossed-up tax and class 1B NICs payable by AEL = £2,187.50 + £280 = £2,467.50

The computation would be different if the tax were to be paid under self-assessment, rather than a PSA. For example:

The income tax rates for grossing up and the NICs rate might be different, as the grossed-up tax would be reimbursed in the tax year after the gift had been made.
Employee and employer class 1 NICs would arise on the reimbursement of the employee for tax paid under self-assessment.

The estimate gives Jim a reasonable idea of how to calculate the liability under self-assessment and a rough guide to the cost (apart from the employee NICs). Self-assessment would also give the company a timing benefit, as the tax would not have to be paid until later. On the other hand, self-assessment could be a considerably greater burden for the employee.

Exit plans?

Most private company shares are not easy to dispose of. In the absence of a market on which to trade them, or a mechanism such as an employee benefit trust or employee share ownership trust (just like an EBT but tailored single-mindedly for shares), you are at the mercy of your fellow shareholders, who may not want to buy you out. Alternatively, you need to make some arrangement whereby the company buys back shares.

If the company creates any form of trading arrangement for its shares, they will become readily convertible assets, and their tax treatment will change. They will become taxable under PAYE and subject to NICs. Any alterations to the rights attaching to employee shares after acquisition may result in an additional tax charge.

Dividends

Deb will become a minority shareholder in AEL, which is a small family owned company. If a dividend is declared, a similar benefit will be received by all the other shareholders, and as the majority of the company’s shares are not employment related securities , and there is no scheme or arrangement to avoid tax, the dividends will be taxed as normal dividends.

A tax charge under section 447 ITEPA 2003 might arise however, if Debs was given a special class of share and the company started remunerating her in dividends, or paying bonuses in dividends.

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Nichola Ross Martin is part of the editorial team at the Practical Law Company: PLC Shares & Incentive, PLC Tax and PLC Private Client. This article is based around one of the PLC Share Schemes and Incentives, features.