Guidance

Guidance on the Capital Gains Tax treatment of Employee Shareholder shares

Updated 17 May 2016

Introduction and summary

The Capital Gains Tax (CGT) treatment of employee shareholder shares (ESS) is provided by sections 236B to 236G TCGA92 introduced by Schedule 23 Finance Act 2013. Amendments are made also to sections 58 and 149AA TCGA92. Changes to these rules have been proposed in Finance (No. 2) Bill 2016. Guidance on the effects of these will be published after Royal Assent.

In broad summary, the CGT treatment is that if the employee disposes of ESS, a gain arising on that disposal may be exempt from CGT, but:

• exemption applies only to the first £50,000 worth of ESS acquired by the employee in consideration of an ESS - the shares are valued at the time they are acquired by the employee - if an individual enters into more than one agreement, the £50,000 limit can apply separately to each - but a single £50,000 limit applies in relation to ESS acquired in consideration of agreements with the same company and/or with companies associated with that company
• exemption does not apply to an ESS if the employee, or an individual connected with the employee at the time of acquisition, has a material interest in the employer company, or in a parent undertaking of the employer company, either at the time the ESS is acquired or at any time within the previous year

An ESS is an ‘exempt employee shareholder share’ if exemption applies in accordance with the conditions above.

If a loss arises on the disposal of ESS, that loss is not allowable if a gain would have been exempt.

The no gain/no loss rule for disposals by an individual to a spouse or civil partner, S58 TCGA92, does not apply if the disposal is of exempt ESS. As a connected person, the spouse or civil partner acquiring the shares is thus deemed to acquire them for a consideration equal to the market value at the time of the disposal.

The ordinary share pooling and matching rules, sections 104, 105 and 106A TCGA92, do not apply to exempt ESS. If an employee holds shares of the same class in the same company and some, but not all, are exempt ESS, then, on a disposal of less than all of the shares held, the employee may determine what proportion of the shares disposed of are exempt ESS. The disposal consideration is apportioned accordingly.

Section 127 TCGA92, which provides that a reorganisation shall not be treated as involving any disposal of the original shares and for the original shares and the new holding to be treated as the same asset, does not apply to exempt ES shares ESS. The new holding thus does not inherit the base cost of the exempt ES shares ESS, or the exemption.

The disapplication of section 127 TCGA92 in relation to exempt ESS extends to that section as otherwise applied by section 135 (exchange of securities for those in another company) or section 136 (scheme of reconstruction involving issue of securities.).

CGT-Exemption of the first £50,000 of ESS (section 236B)

An ESS acquired in consideration of an ESS agreement may be exempt only if immediately after its acquisition the total value of ‘qualifying shares’ which have been acquired by the employee does not exceed £50,000.

Example 1

A enters into an employee shareholder share agreement with his employer, C Ltd. This is his only ESS agreement. Neither A nor anyone connected with him has or has had a material interest in C Ltd (see section 236D). In consideration of the agreement he acquires over a period of time three successive tranches of shares in C Ltd. Tranche 1 has a value of £30,000; tranche 2 £20,000 and tranche 3 £10,000. The shares in tranches 1 and 2 are exempt ES shares. The shares in tranche 3 are not exempt. If shares acquired on a day take the total value of qualifying shares over £50,000 an appropriate proportion of the shares is, for the purposes of applying the exemption limit, treated as having been acquired separately and before the others. The appropriate proportion (rounded down, if necessary to the nearest share) is:

(50,000 − B) ÷ T

Where B is the value of qualifying shares before the day and T is the total value of qualifying shares acquired on the day.

Example 2

B enters into an ESS agreement with her employer, D Ltd. This is her only ESS agreement. Neither B nor anyone connected with her has or has had a material interest in D Ltd (see section 236D). In consideration of the agreement she acquires over a period of time three successive tranches of shares in D Ltd. Each tranche comprises 10,000 ordinary £1 shares in D Ltd. Tranche 1 has a value of £15,000; tranche 2 £20,000 and tranche 3 £25,000.

All the shares in tranches 1 and 2 are exempt ES shares ESS. Of the shares in tranche 3 a proportion: (50,000 – 35,000)/25,000 are treated as acquired before the others. Thus 6000 shares of tranche 3 (having a value of £15,000) are exempt ES shares ESS. The remaining 4,000 are not exempt.

Valuation of shares for the purposes of the £50,000 exemption limit

For these purposes the value of a share (at any time) is fixed at its unrestricted market value at the time when it was acquired by the employee.

A share is acquired by an employee if the employee becomes beneficially entitled to it and it is acquired at the time when the employee becomes so entitled.

If a share is restricted (as defined by section 432(8) ITEPA03), its unrestricted market value is what the market value of the share would be immediately after the acquisition, but for any restriction.

Qualifying shares for the purposes of the £50,000 exemption limit

In deciding whether an ESS acquired in consideration of an ESS agreement is exempt, it may be necessary to take into account other ESS which have been acquired by the employee. The limit applies by reference to the total of the values of ‘qualifying shares’ at the times they were acquired.

For the purposes of applying the exemption limit:

A qualifying share is an ESS:

• in the employer company which entered into the ESS agreement
• in an associated company of that company

Which share is acquired by the employee in consideration of:

• the same ESS agreement
• another ESS agreement with the same employer company
• an ESS with an associated company of that employer company

A company is an associated company of another if one has control of the other or both are under the control of the same person or persons. If a company controls another when an ESS agreement is entered into with an employee, that control is treated as continuing when any subsequent ESS agreement is entered into with that employee. This does not apply, however, if one of the companies was dissolved, two years has since passed and the employee has not in the interim ever been engaged in any office or employment or engaged under a contract for services with any company associated with the dissolved company.

ES Shares are not exempt if the shareholder or connected person has a material interest in the company (S236D)

An ESS is not exempt if, on the date on which the share is acquired, the employee or an individual then connected to the employee has a material interest in the employer company or a parent undertaking of the employer company. Neither is the share exempt if that employee or individual had such an interest at any time in the previous year.

‘Parent undertaking’ is to be read in accordance with section 1162 of the Companies Act 2006. (See extract).

An individual has a material interest in a company if at least 25% of the voting rights in the company are exercisable by the individual, by persons connected with the individual, or by the individual and connected persons together.

An individual has a material interest in a close company if the individual, persons connected with the individual, or the individual and connected persons together have rights as would, in the event of a winding up, give an entitlement to receive at least 25% of the assets that would then be available for distribution.

An individual may be treated as having a material interest in a company by reference to entitlements to acquire rights or by reference to arrangements which enable rights to be acquired. See section 236D(6) to (8).

Extract from Companies Act 2006

Section 1162 parent and subsidiary undertakings

1. This section (together with Schedule 7) defines ‘parent undertaking’ and ‘subsidiary undertaking’ for the purposes of the Companies Acts.

2. An undertaking is a parent undertaking in relation to another undertaking, a subsidiary undertaking, if:

a. It holds a majority of the voting rights in the undertaking, or
b. It is a member of the undertaking and has the right to appoint or remove a majority of its board of directors, or
c. It has the right to exercise a dominant influence over the undertaking.

i. By virtue of provisions contained in the undertaking’s articles, or
ii. By virtue of a control contract, or

d. It is a member of the undertaking and controls alone, pursuant to an agreement with other shareholders or members, a majority of the voting rights in the undertaking.

3. For the purposes of subsection (2) an undertaking shall be treated as a member of another undertaking:

a. If any of its subsidiary undertakings is a member of that undertaking, or
b. If any shares in that other undertaking are held by a person acting on behalf of the undertaking or any of its subsidiary undertakings.

4. An undertaking is also a parent undertaking in relation to another undertaking, a subsidiary undertaking, if:

a. It has the power to exercise, or actually exercises, dominant influence or control over it, or
b. It and the subsidiary undertaking are managed on a unified basis.

5. A parent undertaking shall be treated as the parent undertaking of undertakings in relation to which any of its subsidiary undertakings are, or are to be treated as, parent undertakings; and references to its subsidiary undertakings shall be construed accordingly.

6. Schedule 7 contains provisions explaining expressions used in this section and otherwise supplementing this section.

7. In this section and that Schedule references to shares, in relation to an undertaking, are to allotted shares.