Disposal of employee shares can be more taxing than employees think

Share schemes are a great way to reward and retain employees; however, there will come a point where most employees look to dispose of their shares: because performance targets have been met, they are leaving the business or the business itself is going through a restructuring or sales process. In many instances, this can be a relatively seamless procedure but if the employees receive more for their shareholdings than they are worth, they could be stung with additional taxes.

Unexpected Tax

It is natural for employees to look for the highest price when disposing of their shares but if they receive higher proceeds than their shareholding worth or they have some special contractual rights which mean they get more for their shareholding than their tax market value, this can result in income tax and NIC being charged on the overvalue element on disposal of the shares.

But what does ‘Market value’ mean?

Valuing your shares at the correct market value could mean the difference between the amounts of tax you have to pay upon disposal. The tax rules assume that the parties are not at arm’s length even where commercially they are, so the employee can still pay income tax in some cases even where the parties think the price is right. This could even apply if the sale was conducted under the terms of the company’s Articles of Association, taking account of good or bad leaver provisions, or under a separate Shareholders’ Agreement.

Instead, market value for tax purposes is based on the principle of the price reached in a sale between hypothetical, anonymous parties. This means it shouldn’t reflect personal entitlements or agreements which other shareholders are not signed up to, or which couldn’t be enjoyed by any hypothetical purchaser of the shares.

Tax can often arise where shares are purchased from employees under ‘good leaver’ clauses, whereby departing shareholders commonly receive a more generous price for their shares than other leavers.

But any clauses relevant to only employees must be disregarded when thinking about market value for tax purposes, because the parties envisaged have to be hypothetical. In turn, any clause which provides for a departing employee to receive more than market value on sale could therefore result in a charge to income tax and NIC on any ‘excess’ proceeds.

Preparation, preparation preparation

To avoid unexpected tax bills, employers and employees should ensure they have taken appropriate steps to seek valuation advice well ahead of the future disposal of employee shares. This is particularly the case where special rights attach to shares or the amount of proceeds is established by a separate or personal agreement.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.