ESS was an arrangement under which employees entered into agreements to vary their employment rights in consideration for the receipt of shares, and the first £50k worth of those shares would fall within a specific tax regime. For agreements entered into on or after 1 December 2016, there is no longer a capital gains tax exemption available on the eventual disposal of the ESS shares and those shares will be subject to capital gains tax in the same way as if the shares had not been acquired under ESS. For ESS agreements entered into on or after 16 March 2016 but before 1 December 2016, there was a lifetime limit of £100,000 capital gains tax exempt gains on the disposal of ESS shares. Where shares have been acquired pursuant to ESS agreements entered into prior to 16 March 2016, the capital gains exemption is uncapped.
Although the whole ESS initiative was a bit of a damp squib, those who got in early have the attractive prospect of enjoying tax-free gains in the future. Or do they?
Share for share exchanges are very common transactions and can involve a new holding company being inserted above an existing company as part of a restructuring exercise or a purchaser issuing shares in itself so that a vendor takes a stake in the enlarged enterprise going forward. Unfortunately (and perhaps surprisingly) there is no legislation which allows ESS benefits to flow through into new shares and so ESS shareholders may be left feeling slightly frustrated by such transactions.
The rules work so that any value in ESS shares is ‘banked’ so that any new shares will have a base cost of the ESS shares carried forward. This may be scant reward if HMRC seek to apply a minority holding discount to the ESS shares. Whatever value is applied to the ESS shares at the date of the transaction, any gain will be subject to 20% in the future or 10% in the (rare) cases where Entrepreneurs’ Relief (ER) is applicable.
In some transactions it may be viable to allow ESS holders to continue to hold their original shares rather than being party to the share for share exchange. This is however likely to involve adjustments to the articles to ensure that dividends can flow up to the new holding company without needing to also be paid out to ESS shareholders. Unfortunately, in most cases ESS holders will end up waving goodbye to future benefits and may lose some built up benefits if minority discounts are applied to their share valuation (although this should be resisted).
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