Acquiring company shares…with the taxman’s help!

Alan Pink considers various tax incentives for the acquisition of shares in limited companies.

The fragmented nature of our tax system is probably nowhere more clearly illustrated than in the rules relating to acquiring shares in limited companies.

On the one hand, if you are an employee in the company, the rules seem to go out of their way to make things as difficult for you as possible with the ‘employment-related securities’ rules, of which more later.

On the other hand, a different department of HMRC, and/or different politicians at different times, have laid down that there should be some fairly exciting incentives for share acquisition. So, let’s have a look at some of these.

Enterprise investment scheme

This is something like the third or fourth generation of direct tax incentives for acquiring shares. If you manage to avoid being ‘connected’ with the company (broadly, you and your associates have no more than 30% of it after the share acquisition), you can claim 30% tax relief for the cost of subscribing.

So, an acquisition of £10,000 worth of enterprise investment scheme (EIS) shares is effectively equivalent to making a tax payment of £3,000. Furthermore, if the company is successful (inevitably a substantial proportion of them aren’t), any sale of the shares after the ‘qualifying period’ of broadly three years will be exempt from capital gains tax (CGT).

Even if you have more than 30% of the shares, there’s a potentially very useful CGT relief akin to ‘rollover relief’, under which any kind of gain (not just gains on trading assets) can be effectively matched against your acquisition of the EIS shares, and CGT deferred.

A kind of junior relief called seed EIS (SEIS) relief applies to comparatively small subscriptions at an early stage of a company’s life. The main difference between this and the standard EIS is that the income tax relief is 50%, rather than 30%.

The important thing to realise is that EIS status is not necessarily something obscure or complicated to achieve. The company merely needs to be carrying on any kind of qualifying trade. There’s a long list of these available on the HMRC website and elsewhere, but to sum up brutally, qualifying trades tend to be those that aren’t heavily based on holding land or buildings; so farming, hotels, nursing homes, etc. won’t count as qualifying trades, whereas (say) the provision of computer software services would qualify.

Interest relief

Another way HMRC assists those buying shares is by granting relief for interest paid on loans taken out to acquire them.

Note that it is the purpose of the loan rather than (say) how the loan was acquired which matters. For example, if you take out a loan on the security of your home, or on a buy-to-let property that you own, the interest will qualify for relief under these special provisions if the reason you needed the money was to acquire the shares in a close trading company (a ‘close’ company is one that is controlled by five or fewer ‘participators’).

The interest paid on such a loan is a deduction (subject to overall limits) against your total income, of all kinds, for income tax purposes. The relief is reduced or withdrawn if you get value back from the company. You should note that this relief is available not just for buying the shares, though, but also for lending money, on the director’s loan account (say) to the close company concerned.

Loss relief

It may be thought rather premature to treat the availability of loss relief on shares as an incentive to acquire them, because this is assuming that things are going to go wrong. However, it’s important to bear in mind how the loss relief on shares rules work, because this could influence the way you structure the share acquisition.

Loss relief is available for income tax purposes (not just CGT, as you would expect) where you incur a loss on shares that you have subscribed for in a qualifying trading company. So, note, immediately, the fact that this relief against income (which could reduce your liability by up to 45% of the loss) is not available if you acquire the shares from someone else; only if you subscribe for them (i.e. the shares are issued to you as new shares by the company).

If you make a loss on shares that qualified for EIS relief, the relief is deducted from the amount of your loss; so if (say) you had 30% EIS relief, the amount of your loss is treated as being only 70% of the amount subscribed. Still, even this is very useful if you are (say) a 40% taxpayer. 40% tax relief for 70% of the loss is still equivalent to another 28% of the amount subscribed.

Enterprise management incentive

I now come on to the darker side of the picture, which is the dreaded employment-related securities (ERS) regime.

If you acquire shares in a company in which you are a director or employee, HMRC will tend to look quite hard at the terms under which you got those shares. If it is arguable that you paid less than the market value for them (a fortiori if you got the shares free), there is an income tax charge on you (and a National Insurance contributions charge on the company) equivalent to your having received a salary of the amount of the undervalue. The ERS rules are a serious impediment to the economic growth of the country, in my view, because they make it so difficult for companies to introduce ‘new blood’ into the ownership of their shares.

The enterprise management incentive (EMI) is often trumpeted as being the answer to this problem. In practice, though, there is a severe limitation to the benefit of the rules, as I’ll explain.

What EMI basically enables a person to do is acquire shares at a lesser value than they are worth when that person buys them, without an income tax charge. However, the important catch is that the value at which the shares are acquired must not be less than their value per share at the time the scheme was first entered into by the individual.

Example 1: Shares acquired under an EMI scheme

Herbert is given the right to acquire shares in Bloomfield Limited under an EMI scheme that he joins in 2019. The shares can be acquired for £10 each at any time after the third anniversary in 2022, and subject to various company, etc. performance criteria.

Providing he is able to acquire the shares for £10 each (i.e. their value in 2019), it doesn’t matter if the shares have actually gone up to being worth something like £100 each in 2022 when he gets them; there’s still no income tax charge.

The practical problem, in most EMI schemes, though, is that in the above example Herbert will not have the £10 per share to subscribe even at that later date. Secondly, and most importantly, the EMI scheme doesn’t have the effect of enabling the shares to be acquired for less than they were worth when the scheme was drawn up. So, any idea of getting share value ‘tax-free’ across to an employee is probably misguided.

The most common form of EMI schemes, in my experience in the real world, are ones where an individual can acquire shares when the company is sold. Hence the problem of the employee coming up with the money to buy the shares is easily dealt with.

Business property relief

Business property relief (BPR) is a relief from inheritance tax (IHT), and a very generous one it is too.

Any size shareholding in a private trading (or predominantly trading) company effectively qualifies for 100% BPR; that is, effectively, the whole value of the shareholding is left out of account in deciding how much IHT the owner should pay. Let’s look at an example.

Example 2: Investing in a family member’s business

George is getting on in years and has quite a lot of money saved up, which is going to suffer a 40% IHT charge when he dies.

His son William is running a trading company, and the two agree that this will issue shares to George in return for a much-needed injection of cash. The amount of cash injected becomes, therefore, an equivalent value of shares, which qualify for 100% BPR after George has owned them for the minimum qualifying holding period of two years.

Mix and Match

What many of my readers will have spotted from the above brief summary of the tax advantages available is that there is nothing stopping a number of reliefs applying to the same shareholding.

For example, interest relief, EIS relief, and (if things go wrong) loss relief, as well as relief from IHT, can apply to one and the same shareholding. The common theme to the more generous reliefs is that the company must be a trading one, and preferably one carrying on a ‘qualifying trade’ as defined for EIS purposes.