Tax Charges on Employee Shares – 0% OR 54.6%?

Last Wednesday was a good day; the sun was shining and I had a meeting with a new client, Joe.

“How much tax will I pay when I sell some shares?” asked Joe.

A simple enough question on the face of it, but on such seemingly  straightforward queries are the careers of many a tax accountant forged.

“It depends,” came my almost inevitable reply before seeking further details.

Joe, it turned out, is Sales Director at TechCo, having joined the fledgeling start-up 10 years ago. He has a good relationship with the founder, who has always indicated that Joe would be “looked after” if the company is sold. Joe was given to understand that he had a 4 per cent stake in the business and was told recently that a US group is to buy the company for £10 million.

As a highly competent sales director, it took but a moment for Joe to calculate that he could be in line for a £400,000 windfall. The potential tax implications, however, were another matter entirely.

On further questioning, I established that Joe has always been resident in the UK and acquired his TechCo equity as a reward for being a good employee rather than through family ties. He believed there to be paperwork documenting his 4 per cent stake but would have search for it in his files.

“Your tax bill will be somewhere between zero and 54.6 per cent,” I declared with the utmost confidence.

“I like the sound of zero,” Joe replied.

“Zero is unlikely,” I said, pointing out that if he acquired the shares after 1^st September 2013 and had given up some employment rights as consideration for the shares, he should have a good chance of a tax-free outcome.

A crestfallen Joe revealed that the relevant documents dated back six or seven years, which meant he did not meet the criteria of an employee shareholder.

My next question was whether Joe owned an actual shareholding or share options. “Not sure,” he said, “I just know I will be getting 4 per cent of whatever the company is sold for.”

A few computer keystrokes later and I had TechCo’s Companies House file at my disposal and quickly discovered that Joe was not a shareholder, suggesting that what he held was a share option.

“With a bit of luck it, you may have to pay 10 per cent tax rather than 54.6 per cent,” I offered in the knowledge that everything hinged on the paperwork.

“Has anyone mentioned EMI to you?” I asked.

I was not referring to the Beatles’ record label, of course, but the acronym would prove music to Joe’s ears nonetheless. For EMI is a special tax arrangement for small to medium-sized enterprises, limiting the tax liability on employee share option profits to a 10 per cent capital gains tax (CGT) charge.

If Joe had an EMI, it would be in writing and registered at HM Revenue & Customs. If not, a share option profit could be taxed at 54.6 per cent in some cases.

“You better dig out your paperwork – there’s £178,360 of tax at stake,” I advised.

Joe called me that evening. He had the papers, complete with references to Enterprise Management Incentives – EMI for short. The result? Only 10 per cent CGT on Joe’s £400,000.

The clear lesson, therefore, is to take expert advice from the start when structuring employee equity incentives to avoid reducing their value by more than half.