October 29th, 2012 / Insight posted in

Discount shares hit by income tax

PB writes: I invested in a start-up business a couple of years ago. Since then it has developed and I have been asked to become managing director, working one day a week. I have been offered a salary and an additional 3% of the company for which I would pay only £37 for the new shares when the market value is closer to £30,000. Would I be landing myself with a tax bill if I took the shares? As an alternative, I have been offered options.

HM Revenue & Customs (HMRC) would almost certainly view the shares as employment-related securities, writes Jon Sutcliffe, a partner at Kingston Smith LLP.

If you buy the shares, an income-tax charge would arise on the difference between the market value of the shares (£30,000) and the amount you paid for them (£37).

In the case of many private companies, a further income-tax charge could arise when the shares are eventually sold. This is bad news because income-tax rates are much higher than capital gains tax rates. This additional income-tax charge may be avoided by making a specific election within 14 days of purchase, although this could give rise to an even higher tax charge when you acquire the shares.

In the case of an option there is no income-tax charge until the options are exercised, so the income tax is deferred. On exercise, income tax would be payable on the difference between the market value of the shares at that time and the amount paid for the shares, so the income tax will be higher if the market value has risen.

If certain conditions are met, the options might be granted under HMRC’s Enterprise Management Incentive scheme. In this case, on exercise of the options, the tax would be based on the market value at the date the options were granted, but payable only when the options are exercised, which would be a beneficial solution.