Nil-paid shares are typically used in circumstances where the EMI qualifying criteria cannot be met in full and the creation of a separate class of growth shares is not feasible, but the parties still wish to achieve capital treatment (rather than go down the route of ‘easy, but expensive’ unapproved options).
Nil-paid shares are usually ordinary shares of an existing class which are issued at full price (i.e., at a price equal to the shares’ unrestricted market value), but without collecting the subscription amount from the subscriber until an exit or other specified event occurs (such as a sale, IPO, liquidation or a compulsory transfer by a leaver). Investors may be prepared to agree to this arrangement on the basis that the founder would be committing to paying full market value for the shares (as at the time of issue) at a future point in time, with the founder’s return thereby being restricted to future growth.
Provided the shares are acquired for a subscription price equal to their unrestricted value, the acquisition does not give rise to employment tax liabilities (and the subscription agreement can cater for the eventuality of HMRC disagreeing with the shares’ valuation by providing for an automatic uplift in the subscription price to occur in those circumstances). Assuming a ‘section 431 election’ is entered into within 14 days from acquisition, future increases in the shares’ value will normally be treated as capital subject to CGT rather than employment income.
The arrangement is not entirely free from employment tax liabilities, as the subscription price not paid up is treated similarly to a cheap taxable loan. This has two consequences:
- First, to the extent that interest is not charged or is charged at below the HMRC official rate of interest (2 per cent per annum as at the date of this Insight piece, but this may increase in the future), there would be an annual charge to income tax on the benefit of not having to pay sufficient interest (subject to the availability of an applicable relief). Where a charge to income tax arises, there will also be a charge to Class 1A NICs for the employer company.
- Secondly, if the relevant amount is written off, there will be a charge to employment income tax and NICs on the value written off.
The main risk of this type of arrangement is a commercial one, as in the normal course of events any amount of the subscription price left outstanding will eventually become payable and the value of the shares acquired nil-paid can go down as well as up. In the event the payment obligation is crystallised at a successful exit, a founder holding nil-paid shares should be able to pay the outstanding amount out of the exit proceeds due to him.
However, if the payment obligation was crystallised by an insolvent liquidation, the subscription price left outstanding would be payable – even if at that point the nil-paid shares are worth less than the amount outstanding. A liquidator normally has no choice but to call in any amounts owed to the company; consequently, getting the outstanding subscription amount written off is not an option in those circumstances. For those reasons, a founder will often regard the use of nil-paid shares as too risky, especially where the financial situation of the company in question is less than secure.
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