Rewarding staff with bonus shares – tax implications

Bonus payments may have been a bit thin on the ground since the COVID-19 pandemic hit. Hard-pressed businesses, struggling to meet existing commitments, may balk at the prospect of parting with cash. However, the benefits of having a loyal and satisfied staff may prompt them to consider alternatives to the cash bonus.

The first instinct may be the, “Dear All, We are sure that you will understand, but…” email, however there may be better ways of approaching the situation. This article looks at providing employees with shares or share options rather than money, although there may be other options (no pun intended).

Clearly, an employer must consider terms of employment as to whether there is an entitlement to a bonus. Contractual obligations to pay bonuses may also arise due to custom and practice.

It is also important to manage employees’ expectations. They may be aware of the company’s position, but if they were expecting a juicy bonus and end up receiving a bottle of bubbly, this might just turn out to be a little flat.

Cash v shares

Would it be preferable to issue a new class of shares? A new class of shares could have limited or no voting rights, and could allow for the company to declare dividends to different classes of shareholders at different times. This may make the shares “restricted” shares for tax purposes (and the employees will need to be aware that there are particular tax issues connected with this status)

There are a number of factors to consider, including:

  1. What do the company’s articles of association say?
  2. What is the company’s authorised share capital – this may need to be increased.
  3. Do the existing shares carry pre-emption rights? The current shareholders may not be keen to have their control of the company diluted.
  4. What is the value to the employee?
  5. If these are shares in a private company, is there a market for them?
  6. Are there any shareholder agreements in place which need to be considered?
  7. There will be legal costs involved. These need to be compared with the costs of a straightforward cash bonus.

Taxing bonus shares

The gift of shares in recognition of an employee’s performance or long service will generally be taxable in the employee’s hands as employment income. Since there is no market for most shares in private companies, the employee will need to declare this income under self-assessment, not PAYE. There should, however, be no national insurance contributions on the gift.

The income tax liability will be based on the value of the shares. A minority holding in a private company will usually be heavily discounted and is not simply a fraction of the price of the company. The value will need to be agreed with HMRC.

The company’s accountants may be able to do this, or it may necessary to employ a specialist valuer. Consideration will need to be given to the restricted securities regime if there are restrictions on the shares. It is possible to opt out of this regime.

The company can meet any tax liability on behalf of the employee; however this will give rise to PAYE and NIC obligations on the amount of tax.

Taxing share options

An alternative could be to give the employees the right to acquire options over shares in the company. There are several tax efficient share schemes that generally have the advantage of there being no up-front tax.

The most commonly adopted of these are Enterprise Management Incentives. These are relatively cheap to implement and, of particular interest, the company can impose requirements to limit which employees are able to benefit.

In order for the company to qualify, they must meet requirements as to the trade and the size and ownership of the company.

If one of the tax effective schemes is used, when the shares are sold, often there will be no income tax or national insurance on the grant or exercise of the options. When the shares are sold there will be a capital gains tax charge on the employees based on any uplift in value between the price paid and the price achieved on sale.

Capital gains are currently taxed at 20% as opposed to 40/45% for income, so there is a clear attraction for the employees. With no tax upfront, share options are often preferable to more straightforward gifts of shares.

Conclusion

Tax is important, and it is important to ensure that the best route is chosen for the company’s employees. Shares can be a flexible and (relatively) easy alternative and will provide tangible evidence of management’s commitment to the employees. They also carry the genuine opportunity for a benefit in the future when things pick up, and make employees stakeholders in the company’s improved performance.

Undoubtedly, however, the most important thing will be to manage the employees’ expectations and to try to secure their loyalty and support through the tough times to come.

This guide was written for ByteStart by Shimon Shaw is a solicitor specialising in taxes and tax planning, advising both business and private clients.

Last updated: 17th February, 2021

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