February 23rd, 2015 / Insight posted in The Sunday Times Business Doctor

Avoid tax on issue of shares to partner

EW writes: I am starting a new venture and want to bring in a business partner, increasing her equity stake over the next three years if things work out. I intend to give 10% in year one, 20% in year two and a final 10% in year three. Can I just issue new shares each year or should I consider share options?

It is possible to issue new shares each year. However, this could be taxable, writes Jon Dawson, partner at Kingston Smith LLP.

For each share issue, you will need to value the business to assess their worth. If your business partner is paying less than market value, she will suffer an income tax charge. This could result in her receiving a large tax bill with no additional cash.

Offering share options is an alternative route that shows your commitment to your partner, providing she meets any performance targets you may want to set. In this case you would have to issue unapproved options as the intended holding would exceed 30%. This would result in a similar tax position to issuing shares each year, as stated above.

Another possibility, which would avoid a tax charge from issuing shares, would be to set up the company with the desired shareholding from day one. In this case you could issue a different class of ordinary shares to represent the shares you intended to issue each year and assign different rights to these shares. An election on acquisition would prevent income tax charges arising later.

The shareholder agreement and articles of association could stipulate that each class of shares is non-voting for a period and that they could be bought back at par value if your partner were to leave in this time.