Flowering share plan

Flowering shares provide an opportunity for employees and directors to acquire genuine equity in their employing company. A flowering share is acquired by the employee which delivers value to the shareholder only if the value of the company is above a set threshold. Returns to employees from flowering shares are subject to Capital Gains Tax (CGT).

How the Flowering share plan works

The company creates a new class of share. The rights given to this new class of share are such that, if the equity value of the company is below a given threshold, the shares rank for minimal economic returns. However, if the value of the company is above the threshold, the shares rank equally with ordinary shares.

For valuation purposes, as the shares only receiving economic returns if the threshold is met, the initial value of the flowering share is usually much lower than existing ordinary shares. Therefore, the flowering shares can be issued or transferred to employees for a low issue or purchase price (or a low initial tax charge if the growth shares are acquired for no consideration).

The flowering shares can be subject to restrictions on transfer, or forfeiture if specified conditions or targets are not achieved or the employee ceases employment.

The growth in the share value is subject to CGT which is more attractive than income tax that would apply to a cash bonus arrangement or non-tax advantaged share options. This offers a significant benefit to employees in a high growth companies.

Example

A company is valued at £5m, and a manager is to be incentivised by being given up to 10% of the company value on achievement of an equity hurdle.

A new class of share is created which is entitled to 10% of the proceeds on sale of the company where the company is sold for in excess of £7.5m. If the company is sold for less than £7.5m, these shares have minimal rights to proceeds.

The flowering shares are valued. Due to the £7.5m ‘Threshold’, the value of the flowering shares is £10,000 and the manager buys the flowering shares for this low market value. Alternatively the employee may receive the shares for no price and pay income tax on the £10,000 initial market value.

If the company grows in value and is sold for £10m, the value of the manager’s flowering shares is 10% of the £10m value being £1,000,000. If the company value remains stagnant, or does not grow to exceed the £7.5m hurdle, the manager gets nothing.

Benefits of flowering shares

As with all employee share plans, because the participant becomes a shareholder, their interests are aligned with existing shareholders from the date of purchase. In addition:

• Flowering shares are versatile, tax-efficient arrangements that can allow employees to acquire low cost shares where HMRC approved plans are not appropriate.
• The share value above the purchase price is subject to CGT rules, which are more attractive to employees than income tax treatment that applies to salary and benefits.
• Flowering shares can be used with HMRC tax-advantaged EMI options, combining their commercial and tax benefits.
• Flowering shares are commercially flexible and, when used independently outside of tax-advantaged share plans, there is no value cap on flowering shares that can be acquired.
• Flowering shares can be made forfeitable on employees leaving, with relevant restrictions applying in relation to votes, dividends and other shareholding rights.
• Flowering shares form part of the share capital of the company and are therefore governed by the company’s Articles of Association and subject to the same provisions as other shares on the sale of the company including tag and drag provisions.

Who can use flowering shares?

Flowering shares are most commonly used by private companies, including start-up companies and private equity backed companies where there are substantial growth prospects.

As flowering shares require a new class of shares to be created, they will not generally be appropriate for use directly over shares in UK listed companies. However, flowering shares may be created in a subsidiary of a listed company so that, subject to meeting vesting conditions or performance targets, the flowering shares can be exchanged for shares in the listed company - giving the employees a realisable asset.

Caution needs to be applied to implement flowering shares for EIS companies to ensure that the shares do not affect the EIS tax reliefs but with care, flowering shares can be used by EIS companies.

Tax

On award of the flowering shares:

The employee will pay employment income tax on the value of the shares on the date of receipt less any amount paid for the shares. This would require formal valuation input and, depending on share rights, the tax value could be small. Restricted securities tax elections will normally be entered into.

Disposal of the shares:

On disposal, CGT at a rate of 20% should apply to any gain arising to the employees, giving rise to CGT in the above example of £196,800 (after the annual exemption of £6,000 for 2023/24). A tax rate of 10% would apply if the conditions to claim Business Asset Disposal Relief were met.

Corporation tax and accounting

There will usually be no corporate tax deduction available for the costs of the arrangement. Subject to auditor agreement, a flowering Share plan should result in an FRS 20/IFRS 2 accounting charge based on the fair value of the flowering share awards.

Example of tax advantages

The worked example below contrasts a non-tax-advantaged long-term incentive plan with flowering shares and shows that an advantageous employee tax and NIC result can be achieved.

In this example, 1m shares are subject to the option, the starting share price is £5 and price at vesting is £10. There is no exercise price for the non-tax-advantaged share option.

A participant acquires 1m flowering shares. The rights of the flowering shares entitle the holder to participate in 10% of the company value if the exit value of the company is more than £7.5 million. The participant is subject to income tax and NIC on the market value of the shares at acquisition that is £10,000 (equal to the unrestricted market value at the date of acquisition). After three years, the company is sold for £10 million. There are 9m ordinary shares in issue meaning that the flowering shares receive 10% of the £10m exit proceeds.  

	Non-tax-advantaged share options	Flowering Shares
Employee
Number of shares under award	1m	1m
Income tax and employee’s NIC on grant at 47%	Nil	£4,700
Income tax and employee’s NIC on exercise / vest at 47%	£470,000	Nil
CGT on sale at 20%	Nil	£196,800
Total employee tax cost	£470,000	£201,500
New sale proceeds due to employee after funding exercise price and tax	£530,000	£798,500
Employer
Employer’s NIC at 13.8%	£138,000	£1,380
Corporation tax relief at25% (on amounts subject to income tax and on employer’s NIC)	(£284,500)	(£2,845)
Net employer tax cost	(£146,500)	(£1,465)

*CGT figures include the annual exemption (£6,000 in 2023/24) but no other reliefs.

Other uses of a flowering share plan

The flowering share threshold may be another corporate performance metric rather than just an equity value threshold.

As well as being used for employment reward and planning, flowering shares can be used for effective inheritance and succession. Instead of awarding flowering shares to employees, those shares can be given to family members, directly or through a trust arrangement, for the next generation.

This has the effect of transferring all or part of the value of the company to family members. The value of the gift will be limited for inheritance tax purposes. This is particularly useful in cases where a shareholding would not qualify for inheritance tax business property relief (such as shares in investment companies).