Tax liabilities for growth share recipients stem from the hurdle valuation.
Growth shares are a flexible way to reward people with equity, and they prove to be a powerful tool to motivate and incentivise recipients to help the company grow.
This is because growth shares are issued with a ‘hurdle’ that recipients must overcome for their shares to become valuable.
The hurdle is usually set 10-40% above the current market value of the shares. For example, a company with a share price of £1 may set the hurdle between £1.10 and £1.40.
The hurdle doesn’t just act as the barrier to value, it also sets the tax point for recipients – which is why a fair and accurate hurdle valuation is essential to making your growth share scheme a success for everyone involved.
While HMRC doesn’t approve the hurdle valuation upfront, they will retrospectively review it and either approve it or reject it.
In the case of approval, HMRC will deem the growth shares ‘out of the money’ on issue which is good news for recipients for a few reasons:
No tax on issue: as the shares are out of the money, the recipient won’t incur a tax liability on issue.
The hurdle sets the tax point on sale: when the recipient eventually sells their shares, the hurdle will be the starting point for tax. For example, a hurdle of £1.10 and an eventual sale price of £2 per share would mean only £0.90 per share is taxable.
What happens if HMRC rejects a hurdle valuation?
In this scenario, HMRC would deem the hurdle too low and that the growth shares were issued ‘in the money.’ The recipient would then be charged Income Tax on the difference between the hurdle and their determined market price at the time of issue.
This doesn’t happen often, but it can if companies push too hard for a low hurdle valuation.
A low valuation may sound counterintuitive, but it means a lower hurdle for recipients which then means a greater upside.
Our Valuations team avoid setting the hurdle too low for this very reason. If HMRC were to retrospectively audit your hurdle valuation, your growth share recipients could be hit with a large tax bill.
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