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What are growth shares?

by Jess Allen

Growth shares are a special type of share class that can allow an individual to share in the growth of a company, above an agreed valuation ‘hurdle’.

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 limit. 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.

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.

What are the 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), and 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, all future growth in the business value would be allocated to the growth shareholders. This would mean that the all growth (above the agreed hurdle) would be outside of the freezer shareholders’ estates, which can result in a significant IHT saving if the company value has grown significantly by the date of death.

Where growth shares are implemented, the existing shareholders would technically be making a disposal of their right to participate in any future company growth to the growth shareholders for both IHT and CGT purposes.

Although technically on ‘day 1’ when the growth shares are created, they have little/nil value (as their value is linked to future growth), HMRC have recently been considering the ‘hope value’ of those shares where the company value is likely to increase in the future.

A valuation exercise therefore should be performed by a professional when growth shares are used.

Capital Gains Tax

If the growth shares are considered to have some value, CGT can become payable due to the freezer shareholders disposing of their right to future growth. Generally a gain on a gift of shares in a trading company can be held over, and this would avoid CGT becoming payable. However, if the shares are in an investment company (and thus do not qualify for CGT holdover relief), CGT can become payable by the freezer shareholders when growth shares are given to an individual.

An exception to this is where the growth shares are transferred into a trust, in which case any gain can be held over (even if the company is considered an investment company).

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.

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.

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