Tax on Reverse Vesting

[JamesBM]

I have an involvement with a UK based start up. As a founder I acquired shares for a nominal value in the company that are subject to "reverse vesting" i.e. if my involvement with the company ceases the company has the right to buy back a proportion of the shares (the proportion reducing over time) for a nominal amount The company has recently received external VC funding which means these shares technically have some value (although practically have very little because of VC preemption rights).
What is the position of Irish Revenue with respect to reverse vesting? I read section 128E of the TCA 1997 dealing with forfeited shares which states "In the case of private companies it is often a requirement under the Articles ofAssociation of the company or under a Shareholders Agreement that employees whocease employment with the company must offer their shares for sale. These are not forfeitable shares for the purposes of section 128E."

My assumption is that I had no tax income tax/PRSI/USC liability on the acquisition of the shares as the company was a start up with no value and that the only potential liability was CGT if there was ever a situation I could dispose of the shares?
Thanks.

 

[Barry_QuickCGT]

As a founder, I’d assume the employment-related shares rules are potentially in point here. The key issue is the market value when you acquired the shares, not the fact that a later VC round gave the company a higher headline valuation. If you paid nominal value at a time when the shares genuinely had only nominal market value, there may have been little or no Income Tax / USC / PRSI exposure on acquisition; any later upside would then generally sit in CGT on disposal.

The important wrinkle is section 128E. Revenue’s manual says that where, in a private company, the constitution/articles/shareholders’ agreement require a leaver to offer shares for sale, those shares are not treated as forfeitable shares for section 128E. So a standard reverse-vesting / company buyback clause may well be treated as a leaver sale mechanism rather than “forfeitable shares” in the tax sense. In practice, that means the real questions are: what were the shares worth when acquired, and is this a true forfeiture clause or just a compulsory buyback?

I’d get tax advice on the exact wording of the share terms, as the Irish treatment may depend on whether this is a genuine forfeiture arrangement or simply a leaver buyback.

 

[JamesBM]

Thank you very much Barry_QuickCGT. I think it is defensible that the company had no value beyond nominal when the shares were issued. The reverse vesting is a standard mechanism to "protect the cap table" i.e. to give investors some comfort that it will be economically painful for some founders to leave until after a particular length of time. On leaving my assumption is that CGT would apply to the full sale proceeds given the nominal cost of acquisition.

 

[Villaines]

Yes another risk would be that ultimately you are receiving cash from the company. Cash settled share awards are subject to PAYE.

Imagine that you received no other remuneration, only share awards, at nominal value, on which no PAYE was paid on purchase value, which subsequently are "sold" back to the company for higher value. And imagine that higher value is substantial.

Then you have received cash from the company, but rather than paying IT, USC and PRSI at say 52.2%, plus employer PRSI at ~13%, you're only proposing to pay CGT at 33%.

You can see how Revenue will look at that critically, and wonder if it was a contrived situation - whereby the buyback was inevitable.

But if you can show that the buyback was not inevitable, not reasonably certain at the outset, then I think CGT treatment makes sense - assuming you can stand over the low purchase value and so on.