As part of HM Money Month, Harper Macleod Partner Jo Nisbet asked Andrew Holloway of Johnston Carmichael's Entrepreneurial Taxes team to answer some commonly asked tax-related questions.
A day doesn’t pass without me asking a client 'have you got tax advice on this'. A legal document which ignores the tax is a big risk and likewise is good tax advice without any legal input.
While getting tax advice is always recommended our team do see the same types of questions arising often. So for our tax FAQs we spoke to Andrew Holloway, director and head of Johnston Carmichael's Entrepreneurial Taxes team, who specialises in working with clients across a range of corporate advisory matters.
1. EMI Share Options
Q: EMI share options can be a great tool to help incentivise staff and align the interests of the key employees and shareholders. Legal and tax advice is required for EMI share options which has a cost associated with it, however, there are a host of tax advantages with EMIs. What are the tax benefits of EMI share options compared to non-tax favoured options and other more traditional forms of incentivisation such as bonuses?
A: On the employee side there's a benefit in growth at capital rates (assuming options exercise price is actual market value), and if options/shares are held for over two years, that rate can be as low as 10% as the disposal will qualify for Business Asset Disposal Relief (previously Entrepreneurs Relief). Again, assuming exercise price is actual market value, there will be no employee or employer NIC costs. On the company side there is potential for a significant corporation tax deduction to be achieved on exercise, based on value at that date less exercise price. This can be a lot, particularly for options exercised at an exit, and can be of value in disposal negotiations.
2. R&D tax relief
Q: R&D tax relief can be put to good use by innovative companies. Are you able to tell us about who can claim and what the results of a successful claim could look like?
A: Any company seeking to advance science/technology in their field, and in doing so make an appreciable improvement (in simple terms pushing boundaries and the technology/science frontier) can claim R&D tax relief. Day-to-day spend on “business as usual” is not R&D qualifying! A company can benefit in two ways, either being the receipt of valuable tax credits (which can be reinvested in further R&D), or enhanced R&D spend offsetting profits and reducing a corporation tax bill. Claimants should take care across a range of areas including what projects qualify, the interaction of grants with projects, and allocating costs to projects.
Q: A lot of investors will ask for the company to be Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) qualifying. The SEIS/EIS rules are not straightforward. When should a company get advice and are there any common mistakes you see?
A: As early as you can. SEIS and EIS can be very attractive, and can be navigated as long as due care is taken. Common mistakes I see include closing an intended SEIS and EIS round on the same day which means the whole round will be considered to be EIS, poorly drafted legal documents having unintended consequences, no consideration of all qualifying conditions (and assessment of potential areas of challenge before they become a significant issue), not properly feeling out contentious issues with HMRC and navigating the reasonably “new” risk to capital rules.
4. Tax implications of employees and directors becoming shareholders
Q: Employees and directors becoming shareholders in the business can have knock-on tax consequences and we always recommend that tax advice on this is obtained. What can be the consequences of getting the tax piece on this wrong?
A: Consider income tax consequences at the point equity is received, and ensure appropriate action is taken to consider this. If you get this wrong, for example in not assessing at that point or not entering into a potentially beneficial s431 election, part of the future growth in value could be subject to income tax, as opposed to capital gains tax. This may not really be a “getting it wrong” point, but discussing with an experienced advisor can perhaps lead to a more tax efficient solution being devised. On diligence at an investment round/exit, tax DD forms a key part – a buyer's lawyers will analyse all aspects and options/shares and the Employment Related Securities rules are a huge part of that. Getting it wrong (even if you hadn’t realised it until that point) can see risk profile increased which can have negative implications all round.
5. Founder loans
Q: We see companies trying to clear up a balance sheet by writing off founder loans or converting founders loans to equity. What can the tax pitfalls of this be?
A: Unforeseen income tax consequences from inferior documentation in the future. If employees/directors convert to equity there is a need to assess value and tax consequences. All of these are perfectly manageable, but working with an advisor experienced in the potential issues can mean these are appropriately navigated.
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The importance of getting specialist tax and legal advice can't be overstated and as a basic rule it is more economical for companies to get something right rather than trying to fix a mistake later down the line.