Tax Treatment of Client Equity Stake -- second opinion

[WordIsBond]

1. Everything I write is not worth the paper it is not written on.

I happen to have noticed that this was written in cyberspace, not on paper, and so therefore I choose to believe it has value. Thanks.

2. I know nothing about VAT so make sure you get proper advice on that.

Am advised that since we are exporting services outside the EU it is exempt (whatever terms of payment may be agreed).

3. Company on acquisition: value of shares should be included in turnover, so increasing accounting and taxable profits. There is no tax rule saying what the value should be. From an accounting perspective, you probably should use what you would have received if you'd been paid in cash rather than shares (technically, the issuer has a rebuttable presumption that this should be used and it makes sense for the provider of the service to use the same). You might want to check what the issuer will use as its accounting expense as if you say it is £50,000 to £100,000 and they use £1m then HMRC may think that is strange.

I suppose the question then becomes what I'd have been paid in cash. It's not obvious what that would be.

Good point about how the client will expense it. Though whether they would even talk to HMRC I don't know -- the Yanks have a thing about British tax authorities, going way back.

Spreading the income may be relevant depending on when your co provides the services (similar basis to cash).

This I knew, thanks.

4. Company dividend in specie: It's not a scrip dividend but a dividend in specie.

Thanks. Stupid of me.

The company will pay CT on the deemed market value on disposal less the deemed market value on acquisition. Let's come back to what the "market value" (a tax definition) is likely to be later. The market value on acquisition can be different to the value you include in turnover. But that's unlikely to make a difference from a tax perspective (if the shares are distributed soon after acquisition and the amount included in turnover is not in excess of market value). It's a non-UK company so SD is not relevant.

Understood.

5. Dividend received by shareholder: Ignoring employment income tax stuff for now, "market value" of shares is taxed as dividend (so rates up to 38.1%). This amount will be the base cost on a future disposal.

Good, thanks.

6. So what is "market value"? This is basically the price that a hypothetical purchaser would pay for the shares. A US valuation report is good evidence as to the valuation. But you'd want to update it for the last nine months. A 25% minority discounts seem to have already been taken into account. You can try to apply some more but don't over-egg it. A further 75% discount would be over-egging.

The proposed 75% discount was not in addition to the 25% discount. The valuer arrived at a company value and then applied a 25% discount. My accountant proposed a 75% discount, instead of the 25% discount, because the share holding on offer is much smaller, and restricted. Is 75% then 'over-egging it', 'under-egging it', or in the right general area?

6. The lack of any likely exit suggests that focusing on dividend yield makes more sense. What's an appropriate yield? No idea but I'd probably want closer to 10% than 3%.

Would HMRC be likely to accept a valuation based on a 10% yield? That would give a valuation for tax purposes of around £30K! If they'd accept that I wouldn't bother with the estate valuation.

The December buy-back price (even if happens shortly after you get the shares) is likely to influence the market value (you say that they are worth £100,000 but a week later, when nothing else has happened, the company buys similar shares back for £1m is likely to be indicitive of what the value was a week before).

This is a good point, thanks again. Sounds like I need answers on that. Have assumed that the restriction on the shares would limit any impact on the value from the buyback.

7. There is then the question about how the in ability to sell the shares for two years comes into the valuation. I'd say very little if you don't expect a market for the shares anyway (as a hypothetical buyer would also be expected to hold the shares a long time). If it is a personal agreement (i.e. does not apply to all shareholders) then I'd argue it does not reduce the value but HMRC challenge that for employment taxes purposes.

Thanks.

8. You do need to think about employment taxes. Why do the "employees" get the shares from your co? If it's really because they are employees then the market value of the shares is subject to PAYE/NIC. A section 431 election should be made. That means you would ignore the two year holding period in valuing the shares but prevents their being an employment income tax charge at the end of their two years. It looks like you have 'alphabet' shares and so there must be a risk that HMRC would say that it is related to the employment. If HMRC succesfully argue this and your co doesn't operate PAYE then HMRC will persue yourco for it. There will also be a penal tax charge under s222 if the employees don't reimburse the PAYE promptly. So you need to think carefully about the PAYE/NIC liability being on the company and the s222 risk.

Hmm. My accountant said nothing about this -- perhaps because we have other non-shareholder employees who aren't receiving / don't want any of the shares.

In this case, it seems like the cleanest thing would be for our employee shareholders to purchase ClientCo shares from MyCo for the deemed market value of the shares (whatever that turns out to be) with cash. That makes it a non-issue for Corp Tax and for employment tax, I believe. Does that sound right to you? I have other non-shareholder employees that don't want any of these shares, which might help us argue that this is not employment related, but if it helps to avoid a fight with HMRC over it then just having everyone buy them from MyCo seems easier.

10. The shares need to be reported by yourco on the online version of form 42 (since they are made available by their employer) regardless of whether they are taxed as dividends or as employment income.

Not familiar with form 42 but does this apply if they are bought by individuals from MyCo as soon as they are received?

Thanks again, very helpful as always.

[Iliketax]

The proposed 75% discount was not in addition to the 25% discount. The valuer arrived at a company value and then applied a 25% discount. My accountant proposed a 75% discount, instead of the 25% discount, because the share holding on offer is much smaller, and restricted. Is 75% then 'over-egging it', 'under-egging it', or in the right general area?

I don't know anything about the company. But applying a random percentage discount to another random number is, well, random. Proper valuations should take into account different methods and then use those outputs to come to a proper view as to what the real value of the shares is. Personally, I have issues with this type of discount but I know HMRC accept it in some types of cases. But where there is an expected dividend stream then you can use that as another way to value the shares and use it as a cross check.

To give you an illustration of what HMRC think, have a look here: SVM110050 - Shares and Assets Valuation Manual - HMRC internal manual - GOV.UK

If you can get the valuation report, that will help provide evidence. If you know the buy-back price, that all also be helpful evidence.

Would HMRC be likely to accept a valuation based on a 10% yield? That would give a valuation for tax purposes of around £30K! If they'd accept that I wouldn't bother with the estate valuation.

Again, I know nothing about the company so it's a guess. But if there is no realistic prospect of an exit and you get a dividend stream then a dividend yield method is a sensible way of deciding its value. Whether 10% is an appropriate yield will depend on the risks involved. Google the FTSE100 dividend yield and then decide what risk premium you'd want for whatever the company is. If there are different potential dividend streams (poor, good, fantastic) then use a net present value way of determining the dividends.

In this case, it seems like the cleanest thing would be for our employee shareholders to purchase ClientCo shares from MyCo for the deemed market value of the shares (whatever that turns out to be) with cash. That makes it a non-issue for Corp Tax and for employment tax, I believe. Does that sound right to you?

It's cleaner to some extent but your co still has to make a best estimate of what is market value for PAYE/NIC purposes. You'd also want to keep the evidence of that value.

Not familiar with form 42 but does this apply if they are bought by individuals from MyCo as soon as they are received?

Yes - Other ERS schemes and arrangements: end of year return template, technical note and guidance notes - GOV.UK

[WordIsBond]

Thanks again. The HMRC link was quite helpful.

I used a somewhat comparable FTSE-100 company, multiplied the div yield by 2, as in that HMRC example, and it arrives at a reasonably similar share price to that used by taking the estate valuation and discounting by 75%. Obviously, the multiplication by 2 is as 'random' as the 75%, but it seems like that would provide another data point suggesting that my accountant's 75% is probably somewhat reasonable.

Just one more question. In response to talking about individuals purchasing the shares from MyCo at deemed market value, you said this:

It's cleaner to some extent but your co still has to make a best estimate of what is market value for PAYE/NIC purposes. You'd also want to keep the evidence of that value.

Not quite clear on this. I assumed if the shares were bought for cash from MyCo at deemed MV that there would be no PAYE/NIC ramifications. It's just an asset purchase at market value (which matches cost). Are you just saying we need to keep the evidence, to be able to demonstrate that it really is a MV transaction, and so no PAYE/NIC ramifications? Or are you saying it would still have to be reported as a PAYE/NIC transaction?

[Iliketax]

I assumed if the shares were bought for cash from MyCo at deemed MV that there would be no PAYE/NIC ramifications. It's just an asset purchase at market value (which matches cost). Are you just saying we need to keep the evidence, to be able to demonstrate that it really is a MV transaction, and so no PAYE/NIC ramifications?

Yes.

If a PAYE inspector comes along and your co shows her a bundle of contemperaneous documents showing why the company's best estimate of the value of the shares was the price that the employees paid then the PAYE inspector will be happy. HMRC may still challenge the market value but they would have to challenge the individuals who bought the shares for the income tax and interest on late tax (there would be no NIC and almost certainly no penalties).

If your co just says "er, someone on the internet said something and I'm sure that it was ok, oh look, a flying squirrel you don't see many of them this time of the year" then if the market value is more than the price paid HMRC will challenge your co for the PAYE/NIC/interest plus penalties and there will be further tax and NIC on the s222 benefit in kind. If your co knows where the employees are (and they have sufficient assets) it may be able to get the PAYE back from them.

[WordIsBond]

If your co just says "er, someone on the internet said something and I'm sure that it was ok, oh look, a flying squirrel you don't see many of them this time of the year" then if the market value is more than the price paid HMRC will challenge your co for the PAYE/NIC/interest plus penalties and there will be further tax and NIC on the s222 benefit in kind. If your co knows where the employees are (and they have sufficient assets) it may be able to get the PAYE back from them.

Ah, but what if the "someone on the internet" is somebody who says he likes tax, what then?

Thanks again.