Practical guide: are shares an alternative to paying cash bonuses?

Introduction

ABC has a key employee who was recently made a director. The company usually pays them an annual bonus of £20,000, but this year they are looking at an alternative to help retain their services. ABC would like to use share-based remuneration to reward the director for the same cost as paying a cash bonus, but they would also like to help the director with any income tax liability arising on the share issue. Therefore, the net value of the shares and the payment of the tax liability will need to equal the usual cash bonus. What methods of settling the tax could be suggested, and what reporting obligations would each party have?

Cash bonus

In order to calculate the number of shares that ABC needs to issue, it will first need to calculate what the net cash cost to them would have been if they had paid the cash bonus. This means including the NI cost but also taking into account the corporation tax relief.

Example. Employers’ NI at 14.53% would be due on the £20,000 cash bonus, totalling £2,906. The gross cost is therefore £22,906, but tax relief at 19% brings the net cash cost to the company down to £18,554.

Now that we know the approximate cash cost of paying a bonus, next we will need to know the value of each share in the company.

Share valuation

ABC is an established trading company therefore the most appropriate method for valuing it is by reference to a multiple of its profits. For an overview of this approach, see ACCA Factsheet 167. Let's say that it is determined that the approximate value of the company as a whole is £5 million. There are 1,000 shares in issue so the per share value is £5,000.

However, as £18,554 worth of shares only represents 0.3% of the current value of the company, the £5,000 per share value would need to be heavily discounted to reflect the non-influential minority shareholding being issued.

For shareholdings of less than 1%, HMRC would typically push for a minority discount of 80%.

A discount of 80% would therefore mean the value per share was closer to £1,000 (£5,000 x 20%). Based on this discounted value, if say 13 shares were issued to the director, they would be worth £13,000. What tax implications will this have for the director?

Employment-related securities

Whenever share-based remuneration is used to reward employees (including directors), the shares will fall under the employment-related securities (ERS) legislation and income tax will be due if the employee does not pay the full market value of the shares.

Example. If shares worth £13,000 are issued to the director they will be deemed to have received employment income of £13,000 and income tax will be due at their marginal rate of tax. Being a higher rate taxpayer the director will have a tax bill of £5,200.

Whether NI will also be due depends on whether the shares are considered readily convertible assets. They will be considered readily convertible if there is a market available for them to be sold or realised into cash, or if there are trading arrangements in existence at the time of their issue per ERSM170030.

Therefore providing there is no market available for the shares to be sold, e.g. say ABC has an employee benefit trust which could acquire the shares, the share employment income of £13,000 will be subject to income tax, but not NI.

There will also be no secondary NI charge for the employer.

Reporting

For the director personally, providing the shares are not readily convertible assets the employment income of £13,000 will need reporting on their tax return, with the tax being paid by 31 January following the end of the tax year.

In contrast, where shares are readily convertible assets they will be considered earnings and reportable via the payroll, with PAYE and NI deducted at source.

ABC will also have reporting obligations. An ERS return will need to be submitted online to HMRC by 6 July following the end of the tax year of issue. The return will provide details of the shares issued, their value, and whether anything has been paid for them by the director.

Payment of tax

The receipt of shares will trigger an income tax liability for the director of £5,200, but as the tax is not due until the submission deadline of the tax return there is time for ABC to consider how best to help the director with their tax bill. What could be suggested?

Once the director has been issued with shares they will become a shareholder and therefore be eligible to receive a dividend. ABC could therefore declare a dividend to the director for such an amount that left them with £5,200 net income after tax so that they could pay the tax on the share issue.

It would be advisable for the director’s shares to be of a separate class to the existing shareholders so that a different level of dividend can be declared.

The dividend would be subject to income tax at the rate of 33.75% (for higher rate taxpayers), and therefore in order to receive income of £5,200 after tax, this would equate to a gross dividend of £7,850. The dividend would also need reporting on the director’s tax return with the tax being paid by 31 January following the end of the tax year.

If the dividend allowance (£2,000 currently) is available in full, a lower dividend of £6,830 could be paid, reducing the cost to the company. We will assume that the allowance has been used elsewhere in this case.

The director would therefore be in receipt of a cash dividend that after tax would be equal to the tax liability due on the share remuneration. The end result is that they have received shares in ABC without having to pay anything for them.

CT deduction

By issuing shares and declaring a dividend, ABC has provided the director with remuneration totalling £20,850 (£13,000 + £7,850). However, an often-overlooked relief that companies don’t always claim is the deduction for the value of the shares issued to employees.

Under Part 12 Corporation Tax Act 2009, a company is eligible to deduct from its profits an amount equal to the value of share remuneration taxable on the employee. In ABC’s case this is £13,000.

A tax saving at 19% of the £13,000 share remuneration is therefore available, totalling £2,470, which will bring the net cost to ABC down to £5,380 (£7,850 - £2,470). This is compared to the £18,554 net cost of paying a £20,000 cash bonus, a considerable saving for ABC.