Author: John Forde
Nil paid shares are used in employee incentive planning.
They offer an alternative means to get equity into the hands of employees without an Income Tax charge.
A nil paid share is simply a share where the subscription price is left outstanding at the point the share is issued.
When nil paid shares are used in share incentive planning, the company would typically issue shares to the employee for their current market value. However, the employee would not immediately pay any cash for the shares and the subscription price would be left outstanding.
The intention would be that the employee would only pay the subscription price when he has funds to do so (in practice this would often mean that the shares were not paid for until the company was sold, when the subscription price would be settled using the employee’s share of the sale proceeds).
Any class of shares can be used for this type of planning. However some employers prefer to create a special class of shares; for example a new class of shares with limited voting rights or dividend rights and including provisions that would require an employee to sell back the shares if he stopped working for the company.
The primary advantage of using a nil paid share structure is that it enables shares to be given to employees without the employee incurring an initial tax charge when the shares are issued.
When employees are provided with valuable shares in their employer they are potentially subject to an Income Tax charge (and possibly a national insurance contribution (NIC) charge). This is because they are treated as receiving taxable remuneration to the extent they pay less than full market value for the shares.
For instance, if an employee was issued with £20,000 worth of shares in his employer, and did not pay anything for these shares, he would be subject to Income Tax on £20,000.
Such a charge does not arise with a nil paid share structure as the employee agrees to pay the full market value of the shares at issue. The payment of the acquisition price is simply deferred.
Any future growth in the value of the shares after the date of acquisition should be subject only to Capital Gains Tax rather than Income Tax. The rates of Capital Gains Tax are generally much lower.
During the period the acquisition price is left outstanding there may be an annual tax charge. The subscription price left outstanding would be viewed as a form of employment related loan to the employee, which may result in the employee being taxed on the resultant ongoing benefit in kind. However this should always be significantly less than the charge to Income Tax (and possibly NICs) that would have arisen if an employee was simply given valuable shares.
Also, in certain circumstances this ongoing loan charge will not affect the employee. The outstanding acquisition price will not be subject to tax as an interest free loan if it is less than £10,000 (assuming the employees have no other employee loans). In addition outstanding amounts above £10,000 may not be subject to tax if the company is a so-called “close company” for tax purposes and the individual works in the “actual management or conduct” of the company, or he owns at least 5% of the shares in the company, as a tax relief is usually available in such circumstances.
Nil paid shares are more suitable for private companies than for listed companies. This is because stock exchange rules usually require listed shares to be issued fully paid.
Whilst they have many tax advantages, nil paid shares have a different risk profile to options. With a nil paid share the balance of the subscription price will eventually have to be paid when called (even if the amount that has to be paid is more than the value of the shares at that point because the company’s share price has fallen in the meantime). In contrast, share options do not have to be exercised by the employee when the exercise price is greater than the value of the shares at that point. Moreover, if the company becomes insolvent the holders of nil paid shares could be forced to pay the outstanding amount by a liquidator. Option holders have no such liability.
Nil paid shares are therefore more suitable for managers, who would be more prepared to have “skin in the game” and stake an amount of their own money upon the financial success of the company, than they would be for more junior staff.
A further potential disadvantage to nil paid shares is the lack of a Corporation Tax relief for the employer. When a company uses options it will typically be eligible for a Corporation Tax deduction when the option is exercised on the difference between the exercise price and the market value of the shares at the date of exercise. By contrast nil paid shares do not benefit from such a relief. Nil paid shares are therefore more likely to be considered when Corporation Tax relief is not an important issue for the employer (e.g. if the company does not pay Corporation Tax as a result of carried forward losses).
Fladgate has considerable experience in assisting companies establish nil paid share structures and we are well placed to assist with both the legal and tax aspects of nil paid shares.
John Forde, Partner, Fladgate LLP (firstname.lastname@example.org)