The tax problem is that awarding equity to employees, directors and management triggers income tax on the value on the equity (less what the employee pays). The valuation agreement process which ended on 31 March 2016 (termed a PTVC or Post Transaction Valuation Check) allowed the value to be agreed with a Tax Inspector. In our world this usually meant agreeing the shares were worthless when awarded, the tax charge was therefore nil and you got a letter from HMRC to use on a future due diligence as evidence that the problem had gone away.
The reason why the end of this process is not the end of the world is as follows. Tax valuations fall into two categories – easy and hard.
Hard valuations, with odd fact patterns, can still be taken to HMRC on an informal basis.
Easy valuations have the following logic:
- No term sheet or offer for the sale of the company exists
- The company is worth its net assets (mainly just cash)
- That worth is all in the preferred shares or hurdle shares held by venture capital investors
- There is therefore no value in the ordinary shares awarded to employees or management.
We have never had a valuation turned down by HMRC on this basis, because it is right under UK tax valuation principles – most start-ups fail or they exit with nothing paid to the ordinary shareholders.
We all just need to get used to operating without the PTVC safety blanket e.g. by writing down the valuation logic based on the facts at the time of the share award.
Even if there was an argument that the ordinary shares had some value, while they are shares in a private company with no sale offers, the potential tax charge is on the individual, not the company. Therefore, you just need to have these arguments to hand on a tax due diligence.
Colin Hailey, April 2016
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