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Share and share alike

11th October 2007
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Page 43, 11th October 2007 — Share and share alike
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Passing on shares in your business to key employees can be of benefit to you and

them — but make sure you understand the tax implications. David Ogden reports.

passing on shares to employees can be a useful way of rewarding them for their loyalty. It can also tie key managers into your business and remove the temptation to join a competitor.

However, the UK has detailed rules governing the tax treatment of shares for employees. Anyone who receives shares in the company they work for is considered to receive them by virtue of their employment, so for tax purposes the shares are 'employment-related securities' and sooner or later they are likely to attract a tax charge.

Reward for past efforts

You might simply want to give your manager some shares. If you do this they will receive something of value byvirtue of their employment and must pay income tax on that value.

Although the income tax may be payable by self-assessment after the end of the tax year, unless you have a market for these shares, the manager cannot sell them to pay the tax.This is known as a 'dry' tax charge.

If the value of the shares is low, the solution could be for the company to pay the manager a bonus so the net amount is sufficient to cover his tax.The future growth should be counted as capital gain.

Reward for future efforts

You might only want the employees to share in the future growth. This can be achieved by granting an option over shares. IL is preferable for the option to be over news hares— using your own shares for options could give you an unwelcome tax charge.

The employee can choose when to exercise the option and buy the shares;they might want to do this just before they can sell the shares.

Unless you Lake steps to use one of the arrangements that qualifies for relief from income tax, such as Enterprise Management Incentives (EMI) or a Company Share Option Plan, there will be income tax on the exercise of the option, whether or not the employee sells the shares.

If the shares can be sold, there will probably be National Insurance contributions (NW) due as well.

If EMI is available then the growth in value will be taxed as a capital gain with an effective 10% tax rate, but the company should get a corporation tax deduction as well. If EMI is not available, share options can still be attractive without tax relief.

After all, a gain is a gain, even if you do have to pay income tax on it.

Locking a manager in

If you are working towards an exit within five years, you might decide to give a manager shares but prevent them from selling the shares for a certain period of time; if the manager leaves before the end of this period, they have to give the shares back.

This can create a choice for the manager. Under normal circumstances, provided the restrictions do not last for more than five years, there is no tax when the shares are given but the whole value of the shares is subject to income tax (and possibly NIC) when the restrictions are lifted.

It for example, the share value rises from £100 to £10,000, £10,000 will be subject to income tax (and possibly NIC) when the restrictions are lifted. If the restrictions are only going to be lifted on an exit, the manager should be able to sell the shares to pay the tax. This avoids the `dry' tax charge.

However,the company and the manager can agree that the restrictions will be ignored for tax purposes and the value of the shares will be subject to income tax when they are awarded. In this example, income tax will be payable on £ I 00 and £9,900 will be capital gain.

Sharing the proceeds of a sale

The arrangements described above can be particularly effective in rewarding employees when the company is sold. If the managers have helped to create value, then you might want them to share some of the proceeds.This works well when there is a declared aim to sell the company.

If there is not a well-defined exit anything the manager receives will be a windfall with is no link between effort and reward. There are opportunities and pitfalls you should consider when arranging for your managers or employees Lo receive shares. You need to consider the commercial aspects of any share arrangements for your employees, but you will not want the incentive element to be lost because a badly prepared plan results in an unwelcome or unexpected Lax charge..

• David Ogden is a director of reward consulting at tax advisor Chiltern plc.

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