**A company is owned by spouses in equal shares of a single class. These were issued many years ago. It was formerly a trading company but sold its business and now owns a portfolio of listed securities. The spouses are both directors and receive the modest amount of remuneration for services which HMRC accept as being appropriate to be fully deductible for corporation tax. They wish to give away some of their shares to trusts for their children without losing control. A concern is the employee-related securities legislation. A simple gift of the existing shares would seem to come within the family relationships exception. But the ideal plan is to create 3 classes of shares. A and B identical but only A voting and C non-voting linked to any future increase in net asset value. The mechanics could be by conversion of existing shares or issue of new shares by bonus or rights. C shares could doubtless be issued for a modest price equal to initial market value but not so A or B. It seems fanciful that this operation would entail a general earnings employment income tax charge but the deeming “by reason of employment” provision in the ERS rules is alarming. Is there a safe harbour way of achieving the plan? Do the actual mechanics matter? Conversion of existing shares does not seem to involve an acquisition and none of the shares, even if acquired by bonus or rights, would be restricted or convertible although these shares would not be acquired at market value. Family owned companies who wish to reorganise their share capital must be faced with this issue regularly and it seems a far cry from the mischief the law was meant to counteract.
I received no reply to this post. It does not relate to Trusts as such but does affect estate planning as family company share capital is often reorganised before making lifetime gifts of shares including into trusts.
The SC decision in [2023] UKSC 37 is not just about rewarding employees by a company issuing new shares or share options at an undervalue. It affects a typical reorganisation of a family company where a new class of shares is created by a bonus issue with a view to their being gifted. They are technically issued at less than market value because the dilution in value of the existing holding is not consideration. The undervalue is now deemed employment income for those shareholders who happen to also be employees or directors. And it extends not only to them but to associated persons: ERSM20250. These can include trustees:s993 ITA 2007. If they pay market value for them, e.g. on a rights issue instead, they have to find and inject new money into the company which is simply not wanted for any business purposes so wholly uncommercial to avoid a crass tax charge.
There is an exemption where gifts are made of existing shares by existing shareholders but not if the company first issues bonus shares to them .
“The Court also states that section 471(3) should not be applied in a way that would produce unjust, absurd, or anomalous results [23] – [26], [33]. However, the Court concludes that applying section 471(3) produced no such result in this case [26]”
So the SC has saved judges (the poor diddums) from the difficult task of deciding the issue on the facts of each case, i.e. their actual job, and has handed a dispensing power to HMRC to absolve deserving cases. This illustrates the myopia and compartmentalised thinking of HMRC’s Hydra’s heads. They have been adamant in denying CGT treatment to “founders shares” in MBOs and in asserting the employment income charge:ERSM20240. Now every bonus issue of a family company’s shares is at risk and since the judgment is declaratory no past bonus issue is safe apart from assessment limitation periods.
This highlights the danger of deeming provisions which are surely not meant to catch a common counterfactual but which judges apply narrowly because they cannot have regard to the big picture only to the facts before them, which in this case concerned an employee who probably was the intended target of s471(3) ITEPA (share options) and thus of s421B(3) in a shares case.
It calls into question what can be done to avoid the problem without offending the GAAR.
This is judicial legislation. And every family company now needs to beware of issuing bonus shares to shareholders who are directors or employees or persons connected with them.