Giving Shares to Employees? Avoid This Costly Tax Mistake

Many agency founders reach a point where they want to reward a key team member but do not have the cash available to increase salaries.

Perhaps you have found an exceptional Sales Director, Marketing Director or Commercial Director and want to give them a stake in the business instead.

At first glance, it seems like a great solution.

The employee receives shares in the company and the business preserves cash.

However, there is one important issue that many founders overlook:

Giving shares away for free does not necessarily mean there are no tax implications.

Can There Be Tax on Shares Given to Employees?

Yes.

One of the biggest misconceptions amongst business owners is that if shares are transferred for free, there can be no tax consequences.

Unfortunately, HMRC does not always look at what was paid for the shares.

Instead, HMRC may consider what those shares were actually worth when they were received.

This means that even where an employee pays nothing for the shares, there can still be tax implications.

Why Agency Founders Often Get Caught Out

Agency owners often underestimate the value of their business.

You may not have external investors.

You may not be planning to sell.

You may even feel the business is only worth what is sitting in the bank account.

However, a successful agency often has value because of:

• recurring client revenue;

• long-term customer relationships;

• a strong reputation;

• established systems and processes;

• intellectual property; and

• a talented team.

As a result, shares that are transferred for free may still have value in HMRC’s eyes.

The Real Risk Often Appears Years Later

This is where the stakes can become surprisingly high.

The issue may not arise immediately after the shares are issued. In fact, it often remains hidden for years.

Then one day:

• the agency is sold;

• private equity becomes interested;

• an investor comes on board; or

• the business achieves significant growth.

The founders and key employees receive what should be a life-changing payout.

Unfortunately, this is often when problems emerge.

If the share arrangements were structured correctly from the outset, future growth in value may be taxed as a capital gain.

Depending on the circumstances, Business Asset Disposal Relief may also be available, reducing the tax payable.

However, if HMRC considers that the shares were acquired incorrectly or that employment-related tax rules apply, some or all of the proceeds could potentially be taxed as employment income instead.

The difference can be significant.

For a successful agency exit, the additional tax cost could run into tens or even hundreds of thousands of pounds.

That is why the tax position should be considered before shares are issued, not when the business is being sold.

Shares Instead of Salary

Using shares instead of salary can be an excellent way to attract and retain talented people.

It is particularly common in growing agencies where cash is being reinvested into growth.

However, every situation is different.

The tax treatment will depend on factors such as:

• who is receiving the shares;

• why they are receiving them;

• the value of the business; and

• how the arrangement is structured.

What works for one agency may not be appropriate for another.

Are There Better Alternatives?

Possibly.

Depending on the circumstances, there may be alternative ways to reward key individuals, including share option arrangements.

Some businesses may qualify for tax-efficient share option schemes, whilst others may be better suited to direct share ownership.

The key point is that advice should be taken before any arrangement is implemented.

Don’t Leave It Until the Agency Is Being Sold

One of the most common mistakes founders make is seeking advice after the shares have already been issued.

By that stage, opportunities to improve the tax position may be limited.

If you are considering:

• giving shares to an employee;

• bringing in a senior team member;

• rewarding someone with equity instead of salary;

• offering shares to a consultant; or

• implementing a share incentive arrangement,

it is worth taking advice before anything is signed.

A short conversation now could prevent a very expensive tax mistake later.

Need Advice on Giving Shares to Employees?

If you are considering giving shares to employees or key team members, I would be happy to help you understand the tax implications and available options before any decisions are made.

Getting the structure right at the beginning is almost always easier and considerably cheaper than trying to resolve tax issues when the business is being sold.