Growing SMEs - The Best Tax Incentive Ever?

Posted on in Business Tax

As accountants looking after owner-managed SMEs needing to make a step change in their growth, we are often asked how they should do this. A common solution is to recruit a good senior person to help the owner grow the business further.

However, it's difficult to attract the right calibre person with the budget you have available, so let the tax system help you.....

The best tax incentive revolves around the share capital in your company.

Rather than give away or sell shares up front before the person has proved themselves, you grant an option for him/her to buy shares at a later date. If the person helps grows your company he benefits from that growth by buying the shares at the value they were when s/he joined you.

S/he makes a profit for no initial cost, and your dividends haven't been reduced.

Importantly, there is no tax charge if s/he simply buys the shares and keeps them. More likely, s/he will wait until you sell your higher value company. If s/he has been with you for a year, the tax charge on that gain is only 10%.

A much improved rate on say 40% income tax if you'd had to pay higher bonuses throughout that period.

Your company hasn't taken a risk, and its corporation tax bill is reduced by the gain, so you save 19% corporation tax as IF you had paid him those bonuses.

How does it work?

  1. You write down a set of EMI share option rules such as what happens if your employee leaves your company.
  2. The company grants share options for no cost and no tax charge.
  3. Eg If your company is worth £90k and you company has issued 90 shares, each share might be worth £1,000. If you grant 10 share options, you've immediately given a perceived £10k value to your new person with no cost to you or tax charge to him/her.
  4. You and your new senior executive grow your business over the next, say, 5 years.
  5. You decide to sell your business for, say, £3m. The gain made by your senior executive is £300k less the initial £10k = £290k. After paying 10% capital gains tax of £29k, s/he has received a net £261k over 5 years equating to additional gross salary of over £130k per year. In addition, your company saves 19% corporation tax on the £290k, so its tax bill is reduced by £55k, without incurring any costs.

Your company has benefitted from employing a senior employee who also benefits, if s/he stays with you and helps grow the company. Your corporation tax bill is reduced as if you'd paid him/her normal taxable bonuses, plus you've not paid 13.8% employer NI on top of those bonuses.

Your senior executive knows that s/he benefits from any incremental value he adds to your company and pays only 10% tax instead of a potential 47% combined income tax and NI rate on bonuses.