Growth shares are a common tool used in tax planning in order to limit an individual’s inheritance tax (IHT) exposure, and pass value down to future generations. They can also be used to potentially incentivise key employees and are used as an alternative to a share scheme (for example when the company does not qualify), although there are income tax considerations of this.

How do growth shares work and who are they useful for?

Growth shares are commonly used in companies that have high growth prospects, including investment property companies.

They involve a new class of shares being created which have economic rights that only allow the new share class to have value above the agreed hurdle. These growth shares are then allotted or gifted to individuals other than the existing shareholders (such as other family members, or employees).

The existing shares are reclassified into ‘freezer shares’ that have economic rights up to the agreed hurdle and these shares tend to be retained by the existing shareholders. This is achieved by amending the Articles of Association of the company to create the new classes.

In short, growth shares let the original owners keep the company’s current value while transferring any future increase in value to others (like family — assuming the existing shareholders do not retain any growth shares). This means the future growth is outside the existing shareholders’ estates for inheritance tax purposes, which should result in an inheritance tax saving on their death.

The growth shares tend to be created with no voting rights, such that the freezer shareholders retain control over the company (which can be an important consideration of planning). They can also be created with or without dividend rights, depending on the preferences of the existing shareholders.

For example, in a company worth £1m, the existing shareholders would hold freezer shares that retain economic rights to the first £1m of company value. The growth shares can then be created to have economic rights on a winding up (or sale) to any value exceeding £1m.

Growth shares tax considerations

Growth shares are a useful planning option where a shareholding is not expected to qualify for Inheritance Tax reliefs (such as shares in an investment company) or to pass future value in a tax-effective manner to younger generations.

Gifting shares away in investment companies can trigger a considerable amount of Capital Gains Tax (CGT) for the donor, even where no cash is received. The shareholder may also rely on those shares for capital or income (through dividends) so gifting the existing shares away can be seen as an unattractive option.

Growth shares can provide a solution for these issues and the main tax considerations of growth shares are summarised below:

Inheritance Tax

If growth shares are implemented, any increase in company value beyond the agreed hurdle would belong to the growth shareholders. As a result, this growth would no longer form part of the freezer shareholders’ estates, potentially leading to significant Inheritance Tax (IHT) savings if the business grows substantially before the shareholder’s death.

By creating growth shares, the existing shareholders are essentially transferring their right to participate in the future growth of the company to the growth shareholders, which has implications for both IHT and Capital Gains Tax (CGT).

Although growth shares technically have little or no value when they’re first created (since their value is tied to future growth), HMRC may argue that these shares carry some “hope value” if there’s a reasonable expectation of future growth.

For this reason, it’s important to consider obtaining a professional valuation when using growth shares to ensure these tax implications are managed appropriately.

Capital Gains Tax

If the growth shares are considered to have value, the freezer shareholders may be liable to pay Capital Gains Tax (CGT) because they are effectively disposing of their right to any future growth.

Normally, when shares in a trading company are gifted, any gain can be deferred or “held over,” meaning CGT is not immediately payable. However, this relief does not apply to shares in investment companies, so freezer shareholders could face an immediate CGT liability when gifting growth shares in those scenarios.

There’s an exception when growth shares are transferred into a trust. In this situation, the CGT can be deferred (held over) even if the shares are in an investment company, so the tax does not become immediately payable.

Income tax (if given to an employee)

If growth shares are given to an employee as a method of incentivising and rewarding that employee, income tax is likely to become payable by the employee as the shares would be received by virtue of their employment.

There are ways in which income tax can be mitigated, such as using ‘nil paid’ shares, which we can advise on in more detail if required.

Explore growth shares without the stress

To discuss any of the above further and establish whether growth shares may be an option for your company and tax planning, please contact us .