Employee share awards – let’s talk about tax valuations

The award of shares to employees can be a powerful incentive. Employee share ownership enables individuals to participate directly in the company’s growth, aligning their interests with those of existing shareholders. This shared ownership mindset can help foster long‑term commitment and engagement.

Share awards become particularly valuable when shareholders are working towards a future sale or exit. Allowing employees to share in the eventual value created can help drive performance, support retention and ensure that everyone is working towards the same strategic objectives.

Why valuations matter when awarding shares to employees

There are many factors to consider when implementing employee share awards, but in most cases obtaining a robust tax valuation is essential. Too often, however, the importance of obtaining an appropriate valuation is underestimated.

This is commonly only spotted once a company is going through a sale due diligence process and can have a significant impact on the transaction.

Below, we explore why valuations matter from both a commercial and a tax perspective.

Commercial benefits of having a valuation

From a commercial standpoint, a valuation could be helpful to:

Determine the size of awards:

Companies often have an idea about how much ‘value’ they would like to award each employee. However, without a share valuation, a company will not know the number of shares required to achieve this. A tax valuation should determine the price that the shareholding to be awarded to the employee might reasonably be expected to fetch on an open market sale. However, it should be noted that the tax value might not necessarily be a reliable indication of the value which a shareholder would realise on a ‘whole company sale’. For example, a ‘minority interest discount’ may be applicable when valuing small holdings to reflect the lack of control the holding confers to the shareholder. Such a discount would not be factored into the share value in a whole company sale.

Set the right price:

A valuation helps companies decide whether employees should pay anything for their shares and, if so, how much. It may be the case that an employer would expect employees to pay the tax market value for their shares (i.e. the price which the shares would reasonably be expected to fetch on a sale in the open market).

Tax implications

For UK tax‑resident employees, understanding the tax market value of the shares at the date of acquisition is critical.

In the case of an employee acquiring shares, an income tax charge will ordinarily arise if an employee pays less than the tax market value for their shares. The amount subject to an income tax charge is based on the difference between the price paid and the tax market value at acquisition. Without understanding the tax market value of the shares, it may not be possible to determine whether, or to what extent, an income tax charge will arise.

Failing to understand share value at the point of acquisition can have significant consequences. The risk is that tax is underpaid, leading to potential interest and penalties from HMRC. The tax consequences of underpayment of tax will depend on whether the shares are readily convertible assets (RCAs), or not.

Readily convertible assets

Broadly, shares will be treated as readily convertible assets (RCAs) if they can be freely converted into cash. They will also be treated as RCAs where arrangements exist that enable, facilitate, or are likely to result in their conversion into cash. However, there are other instance where shares will be RCA. For example the shares are in a company which is controlled by another company which is not listed.

If the shares awarded to an employee are RCAs and are provided at a discount (i.e. at a price which is less than the tax market value):

• The employer must operate PAYE
• The employer must account for income tax, employer NIC, and employee NIC
• PAYE must be operated based on the best reasonable estimate of the share value at the time

If the employer fails to operate PAYE correctly, significant penalties can apply.

However, obtaining a professional valuation and applying PAYE in line with that valuation can provide the employer with a defence that PAYE has been operated correctly and significantly reduce HMRC penalty exposure. If the shares are RCA and a valuation has not been carried out, this could cause significant concern for a buyer on a due diligence exercise.

Non-RCA shares

If the shares are not readily convertible assets, the obligation to pay any income tax will rest with the employee. The employee should pay any income tax due via their self-assessment tax return for the relevant tax year.

Without a valuation of the shares, employees may find themselves uncertain about the value of their shares and the tax they are expected to pay. This could make the share award more stressful than rewarding. A valuation gives employees clarity and confidence about their tax position.

A common valuation mistake

We occasionally see cases where directors assume that the shares being awarded to employees are worthless – often because the company is loss‑making or has limited assets. This assumption is almost always incorrect.

If shares were genuinely worthless, why would an employee want them?

In reality, most shares carry ‘hope value’, reflecting the potential for future growth.

If a company starts to perform strongly in the future and the employee sells their shares for a significant amount, it becomes difficult to argue that the shares had no value at the time of acquisition. This can be particularly challenging to justify to a buyer, or in some instances, HMRC. Without a professional valuation to rely on, that argument becomes even weaker.

The takeaway

If you are considering awarding shares to employees, obtaining a defensible valuation is essential. We recommend that you seek professional advice from specialists with deep experience in tax valuation. This is especially important where the shares may be RCAs.

How can PKF Francis Clark help with valuations?

Our team has significant experience supporting companies designing and implementing bespoke share plans for their employees.

At PKF Francis Clark, our specialists have expertise in producing robust, tax‑focused valuations for employee share awards – valuations which will stand up to scrutiny during due diligence or HMRC enquiry.

Beyond valuations, we can also support you through many other steps involved when implementing an employee share plan. Find out more here.

If you are considering awarding shares to your employees, please get in touch with our share plan specialists.