Salary sacrifice for company shares and options
I have been offered some shares in the Company I work for but I don’t have the money spare to pay for them. Can I give up some of my salary and be given shares instead? The answer to this is yes – read on, but is it worthwhile?
It is not uncommon for employees whose salaries are perhaps lower than market rates to be given options or other share rights to boost their package. This happens in companies of all sizes, whether larger fully listed companies or small start-ups.
If you are thinking about receiving or offering shares in this situation, here is a worked example, very typical of situations where we are brought in to help.
John leads a company and has identified the need for a finance director or CFO, perhaps to supplement the accounts team in the company in the lead up to an AIM listing or funding round though it might be to promote the current accounts manager who he sees has potential. He has spoken to various people including some recruitment agents and realises that, at least initially, the business cannot afford the market rate base salary for this role in his sector and location.
John thinks Sarah would be perfect for the role and negotiates a deal so that she accepts a reduced salary sacrifice and receives a number of shares of similar value each year. This might be as she joins or after she has been with the company for a while.
It is vital that any sacrifice of salary (or bonus) is done before the salary
falls due and payable otherwise Sarah will be taxable as if she had received
Employment law advice should be sought also in terms of any employment contract or waiver on this matter.
Sarah might acquire the shares in various different ways. There might be a gift from John, an option granted by the company or an employee trust (perhaps under an Enterprise Management Incentive Scheme) or by a direct issue of shares.
2. A gift from John might have personal tax implications for John.
3. The value of receiving shares immediately will be a taxable receipt to the extent the full market value is not paid.
4. The company might get a corporation tax deduction when the shares are received by Sarah, but there is no immediate deduction for the grant of an option.
5. For accounting purposes, any share based remuneration must be valued and expensed unless the company accounts under FRSSE.
6. UK company law requires that Sarah will have to pay at least the nominal value for the shares if they are newly issued by the company (with limited exceptions).
7. UK company law also says that shares cannot be issued free and in return for future services, or employment but may be issued for past services, provided there is an independent valuation confirming the allotment is fair.
John and Sarah see that there are various company law issues. They also note that the primary purpose of this is not to save tax and they do not want to be seen by employees, shareholders or customers as being involved in any tax avoidance scheme. However, they do want to reduce the wages bill, they cannot afford to increase the tax costs and wonder if there are any deductions to offset the set up costs.
After some discussion they decide to allow Sarah to acquire newly issued shares through an HMRC qualifying Enterprise Management Incentive (EMI). They feel comfortable that this is a statutory arrangement specifically designed to incentivise growing, entrepreneurial businesses with gross assets less than £30 million. Under this arrangement Sarah is given the right to buy shares now for a discounted price (just the nominal price per share).
8. There is no tax liability for Sarah when the right is granted.
Sarah and John want Sarah to become a shareholder soon so she exercises the option to buy the shares within 6 months.
9. On buying the shares under the EMI option, Sarah has to pay income tax on the discount given when the option was granted but there is no national insurance contributions (typically 2% for Sarah and 13.8% for the company) if there is no likely market for the shares and the shares are otherwise not ‘readily convertible assets’. This would be a saving for the company and for Sarah over receiving salary in cash but the tax will need to be paid out of other income.
10. The company can also get a valuable corporation tax deduction in the year the option is exercised roughly equal to the value of the share acquired less the nominal amount paid by Sarah.
Sarah is pleased with the result that means she has become a shareholder in the company at a tax cost equal to 45% (or less) of the market value of the shares. Sarah also feels comfortable with the price as it was valued independently and agreed with HMRC before the option was granted.
Sarah realises that in her CFO role, she or someone in her team will need to administer the EMI options, that she thinks might be given to the new Chief Operations Officer soon to be appointed. She wants to keep it simple.
11. There will be documentation for the salary sacrifice, perhaps to amend the articles of the company or the shareholders’ agreement, to grant the options, notify HMRC and also to agree share values with HMRC and prepare annual returns.
Sarah would like to deal with this in-house eventually but currently she does not have the skills or resources. Having reviewed the costs and the savings she decides to appoint RM2 to support and administer the EMI plan in the same way that she outsources the payroll to maximise utilisation of her finance team and the HR team.
Sarah builds up her stake in the company, as do certain other key executives and a few years later the company receives an offer for the whole of the issued share capital of the company, of which 10% or so is owned by Sarah and other key executives. The company has grown in profitability and now the shares are worth a lot more than the original values agreed with HMRC. An offer is made to all shareholders and advice is taken about selling the company. Sarah and John sell their shares.
12. Sarah’s profit on the sale of her shares will normally give rise to a capital gain. The taxable amount is calculated as the sale proceeds less the value of the shares agreed with HMRC when the option to buy the shares was originally granted, minus her annual CGT allowance, currently £10,900 (assuming this is otherwise unused). The resulting chargeable gain is likely to be taxable, with the benefit of Entrepreneurs’ Relief, at just 10%.
So, was it worth Sarah taking a reduced salary and getting the right to shares?
Please contact RM2 (020 8949 5522 / firstname.lastname@example.org) or consult our free fact sheet downloads for more information about employee share schemes.