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Guidance on the Capital Gains Tax treatment of Employee Shareholder shares
By HMRC

Contents

  1. Introduction and summary
  2. Changes in 2016 - for employee shareholder share agreements entered into after 16 March 2016

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

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

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

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

  7. Extract from Companies Act 2006

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.

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 (where the shares disposed of were acquired in consideration of an ESS agreement entered into after 16 March 2016 the amount of exempt gains is limited to a lifetime limit of £100,000, and amounts above this limit are chargeable gains), 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 (for shares acquired in consideration of an employee shareholder share agreement entered into after 16 March 2016 the amount of gain exempted will be limited to the first £100,000 arising to any individual during their lifetime).

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. This rule is modified for transfers of shares acquired in consideration of an employee shareholder share agreement entered into after 16 March 2016. The rule operates as before (transfer at a value equal to the market value at the time of disposal) where the spouse making the transfer has at least that amount of their £100,000 lifetime ESS limit available. Where the market value exceeds the available amount of ESS limit available the transfer is deemed to happen at an amount that gives rise to an amount equal to the amount of the ESS limit available. Where there is no ESS limit available (it has all been used up on previous disposals by that individual) the transfer is deemed to happen at an amount that gives rise to no gain/no loss.

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.).

Changes in 2016 - for employee shareholder share agreements entered into after 16 March 2016

The amount of gains on ESS which are exempt from capital gains tax depends on the date of the employee shareholder share agreement. To be ESS, the shares must have been given in consideration for entering into an employee shareholder share agreement. If that agreement was entered into on or before 16 March 2016 then the amount of gain that can be exempted (treated as not chargeable under Section 236B TCGA 1992) is without limit. If the shares were acquired in consideration of an employee shareholder share agreement entered into after 16 March 2016 then gains treated as exempt are subject to a lifetime limit of £100,000. Note that the critical date is the date the agreement is entered into not when the shares are actually transferred to the employee.

The lifetime limit is per individual, and covers all employee shareholder share agreements they have entered into. Once the limit has been reached (ie the individual has realised gains on shares acquired in consideration of an employee shareholder share agreement entered into after 16 March 2016 of £100,000) any gains above this amount are chargeable gains.

Changes were also made for transfers to spouses/civil partners of shares acquired in consideration of an employee shareholder share agreement entered into after 16 March 2016. The rules are:

  • Where the market value at the time of transfer would give rise to a gain which is less than the lifetime limit available to the transferor spouse, the transfer is deemed to take place at an amount equal to the market value
  • Where the market value at the time of transfer would give rise to a gain which is more than the lifetime limit available to the transferor spouse, the transfer is deemed to take place at an amount which gives rise to a gain equal to the amount of available ESS lifetime limit
  • Where the transferor spouse has no ESS lifetime limit available (ie the entire £100,000 has already been ‘used up’ on previous transfers of ESS) the transfer is deemed to take place at an amount which would give rise to neither a gain nor a loss

Example
X enters into an employee shareholder share agreement with her employer Y Ltd on 22 March 2016. This is her only employee shareholder share agreement, and neither X nor anyone connected with her has or has had a material interest in Y Ltd (see section 236D). In consideration of the agreement she acquires 10,000 shares valued at £40,000.

Y Ltd does well, and X decides to transfer half of her shares to her husband. At the time of the transfer each share is worth £10, so the 5,000 shares she is transferring are worth £50,000.
The market value of the shares (£50,000) would give rise to a gain of £30,000 (£50,000 less £20,000). This is less than the available ESS lifetime limit (which is £100,000) so the transfer is deemed to take place at £50,000. X has used up £30,000 of her ESS lifetime limit, and has £70,000 of this limit to carry forward.

The company continues to thrive, and X sells the rest of her shares at a time when they are worth £25 per share. She sells her 500 shares for £125,000 which results in a gain of £105,000. X has £70,000 of her ESS lifetime limit available, and so of this £105,000 gain, £70,000 is treated as not being a chargeable gain. The remaining £35,000 is a chargeable gain, and X will have to pay tax on this gain subject to any annual exempt amount or losses she has to set against it.

S127 TCGA 1992
With the introduction of the £100,000 lifetime limit changes were needed to the way employee shares are treated on reorganisation. When shares acquired through a post 16 March 2016 employee shareholder share agreement are exchanged for other shares in a reorganisation, Section 127 TCGA92 will continue to be disapplied (as before) but the following consideration is deemed to be received for the original shares:

  • If the disposal (using market value) would give rise to a gain which is more than the available ESS lifetime limit, then the transfer is deemed to take place at an amount that gives rise to a gain equal to the available ESS lifetime limit

  • If the disposal (using market value) would give rise to a gain which is less than the available ESS lifetime limit, then the transfer is deemed to take place at market value

  • Where the shareholder has none of their ESS £100,000 lifetime limit available the disposal is deemed to be at a value that would give rise to neither a gain nor a loss

  • If the disposal would give rise to a loss, the deemed transfer value is that value which would give rise to neither a gain nor a loss

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:
  • It holds a majority of the voting rights in the undertaking, or
  • It is a member of the undertaking and has the right to appoint or remove a majority of its board of directors, or
  • It has the right to exercise a dominant influence over the undertaking.
  • By virtue of provisions contained in the undertaking’s articles, or
  • By virtue of a control contract, or
  • 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.
  1. For the purposes of subsection (2) an undertaking shall be treated as a member of another undertaking:
  2. If any of its subsidiary undertakings is a member of that undertaking, or
  3. 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:
  5. It has the power to exercise, or actually exercises, dominant influence or control over it, or
  6. It and the subsidiary undertaking are managed on a unified basis.
  7. 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.
  8. Schedule 7 contains provisions explaining expressions used in this section and otherwise supplementing this section.
  9. In this section and that Schedule references to shares, in relation to an undertaking, are to allotted shares.