Why You Should not Issue Shares to Employees at Nominal Value – Tax Risks, Pitfalls and Better Alternatives
While incentivising key staff with the issue of new shares at nominal value may be simple in theory, this approach almost always triggers significant tax and compliance issues that can be costly for both the company and the employee.
In practice, issuing shares to employees at undervalue (i.e., less than the market value of the company’s shares) is one of the most common causes of HMRC challenges in the private company space. It is always suggested to seek advice from legal and tax advisors to better understand the risks and the more efficient alternatives before issuing shares to a key employee.
The Tax Trap: Why Nominal Value Issues Are Problematic
- Employment-Related Securities (“ERS”) Tax Charges
Whenever employees acquire shares because of their employment, the shares fall under the employment-related securities regime.
If the shares are issued at less than their true unrestricted market value, the discount is taxed as employment income. This can trigger:
- PAYE obligations for the company;
- Employer and employee NIC; and/or
- Risk of penalties if PAYE is not operated correctly.
HMRC takes a particular interest where alphabet shares are handed to employees for a nominal amount but carry full economic rights (e.g., dividends, capital value, exit proceeds).
- Restricted Securities and the s.431 Election
Even where shares come with restrictions (e.g., non-voting, forfeiture on leaving), the default tax position is still based on the full market value.
A section 431 election is essential to prevent a second tax charge on future growth, otherwise employees may owe additional tax later.
- Valuation Exposure
Issuing shares at nominal value requires a defensible valuation to satisfy HMRC and this can typically be arranged with the company’s accountants or specialist business valuers.
A low or informal valuation increases the risk of:
- HMRC enquiry;
- Reassessment of the discount; and/or
- Additional tax, interest and penalties.
Submitting a valuation to HMRC provides protection, but be aware that only EMI share options will require HMRC’s prior approval. For other ERS, the company will retain a copy of the valuation in case HMRC enquire about the value of the shares in the future (particularly when the employee comes to sell their shares).
- Corporate Governance Complications
Creating a new share class and issuing it to employees typically requires:
- Updating the company’s Articles of Association;
- A Shareholders’ Agreement (either a new one or amendment to an existing one);
- Written board and shareholder resolutions;
- Companies House filings; and
- Updating the company’s cap table (if shares were issued).
Issuing shares at nominal value can also create red flags during due diligence as buyers and investors typically scrutinise the company’s records (particularly, historic share issues, any undervalue transactions, missing s.431 elections or weak valuations). These issues can delay a deal, reduce the sale price, or expose founders to warranty claims or having to provide extensive indemnities.
Better Alternatives: How to Incentivise Employees Without Tax Pitfalls
Issuing shares at nominal value is rarely the right solution. The good news is that several well-established alternatives avoid these risks entirely.
- EMI Share Options
For qualifying companies, Enterprise Management Incentive (“EMI”) options offer exceptional tax efficiency and flexibility, including:
- No tax on grant;
- Usually no tax on exercise if options are priced at the market value agreed with HMRC;
- Growth taxed as Capital Gains Tax, not income tax;
- Minority discounts can legitimately reduce the valuation; and
- Where EMI share options are exercisable on an exit, the ability to have a cashless exercise (i.e., the exercise price is deducted from the sale price).
Where available, EMI is almost always the most efficient alternative to a nominal-value issue.
- Growth or Hurdle Shares
If EMI is not available, growth shares offer a clean and commercially focused structure.
How they work:
- Employees receive shares that only participate in value above a predetermined hurdle (typically the current market value or a value above the current market value).
- This keeps the upfront market value of the shares very low.
- Employees pay minimal tax, and only benefit once the business genuinely grows.
This directly avoids the “undervalue” problem associated with nominal-value shares.
- Full Market Value Subscription with Loan Funding
If the parties want to proceed with a direct share issue, employees can subscribe at full market value and finance the subscription through a structured loan from the company.
This:
- Eliminates the undervalue issue;
- Avoids ERS income tax charges; and
- Allows repayment through dividends.
It is simple, compliant, and far safer than issuing shares at nominal value.
Summary
Issuing shares to employees at a nominal price can seem like a quick win but it almost always leads to tax liabilities, compliance risks and HMRC scrutiny.
A better strategy is to adopt a structure that avoids income tax charges, properly aligns employee incentives, minimises risk for the company and is more resistant to HMRC review.
EMI options, growth shares, and loan-funded full-value subscriptions all provide cleaner, safer and more efficient alternatives.
With the right structure, employee equity can be a powerful incentive without creating unnecessary tax headaches.
If you are considering issuing shares to key employees, please get in touch with our experienced solicitors in our corporate department. We usually offer a no-cost, no-obligation 20-minute introductory call as a starting point or, in some cases, if you would just like some initial advice and guidance, we will instead offer a one-hour fixed fee appointment (charged from £250 plus VAT depending on the complexity of the issues and seniority of the fee earner).
Please email wewillhelp@jonathanlea.net providing us with any relevant information ensuring that any call we have is as productive as possible or call us on 01444 708640. After this call, we can then email you a scope of work, fee estimate (or fixed fee quote if possible), and confirmation of any other points or information mentioned on the call.
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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.