Tax

Today, Rachel Reeves, the Chancellor of the Exchequer, delivered the 2024 Autumn Budget, the new Labour government’s first following their election to office in July.

Among various other changes related to business taxation, Ms Reeves announced that the top rate of capital gains tax (CGT) that applies to the sale of shares would rise from 20% to 24% with effect from 30 October 2024. This rise was not unexpected, and is somewhat more moderate than some commentators expected. Please see here for further discussion of other changes announced by Ms Reeves, including the taxation of carried interest.

Shares sold prior to 30 October 2024 should be subject to CGT at 20%, whereas shares sold on or after this date should be subject to the increased rate of 24%. Where shares are sold pursuant to the satisfaction of conditions (e.g., securing regulatory approvals), they will generally be deemed ‘sold’ when the contract for sale becomes unconditional.

In addition to the increased CGT rate, the employer National Insurance contribution (NIC) rate will increase from 13.8% to 15% with effect from April 2025, which will have an impact on cash based MIPs (as discussed further below).

UK capital gains tax

Gains (or profits) on the sale of shares have been taxed at the headline rate of 20% since 2016. Additionally, ‘business asset’ owners can avail of a reduced rate of 10% (14% from 6 April 2025 and 18% from 6 April 2026) provided certain conditions are satisfied (but are unlikely to apply in typical private equity structures). Many other jurisdictions have similar regimes under which capital gains are taxed at lower rates compared to income:

As well as the lower rate, the UK tax regime affords taxpayers some other benefits, including the ability to defer CGT on the sale of shares by “rolling” the gains into new securities issued by the buyer. Taxpayers also benefit from a tax free allowance (currently set at £3,000), the ability to transfer assets to certain persons (such as a spouse) on a tax free basis (enabling the sharing of the tax free allowance) and the ability to “carry forward” CGT losses to shelter against gains realised on later disposals. The new government has not announced any intention to make changes to the wider capital gains tax rules; for now, we just know that the headline rate will increase to 24% from 30 October 2024.

What does the rate increase mean for management incentive plans?

There are many reasons why share-based management incentive plans (MIPs) are widely used by private companies, in particular those with a financial sponsor. Principally, MIPs operate to align the participating managers’ commercial interests with those of the sponsor by delivering gains linked to the financial performance of the underlying investment – usually on an exit. However, sales of MIP shares attract CGT so the lower tax rate compared, for example, to a cash bonus arrangement (currently taxed at up to 47%, including employee NIC) has also made them more attractive. The change from 20% to 24% seems relatively modest, and is still favourable compared to other countries, so provided structured correctly, share based MIPs can still provide the best tax outcome for parties, and we don’t expect any immediate knee-jerk reactions in the market.

That being said, interest in alternative MIP structures may now increase, in particular for junior managers, mid-investment cycle MIP issuances or MIP re-sets. The effectiveness of share-based MIPs somewhat relies on a robust upfront valuation which can be time-consuming and expensive, sometimes resulting in a high ‘buy-in’ cost for managers. The new capital gains tax rate could now mean that a cash based MIP is seen as a useful alternative where bespoke structuring or an extensive valuation exercise is required to issue shares.

What alternative structures are available for MIPs?

The most common alternative is a “phantom” share plan or cash bonus payable on an exit. Provided an effective communication strategy is adopted, these arrangements can have the same incentive impact as a share based MIP, and there are some benefits, such as greater flexibility setting performance conditions and amending terms. The key difference compared to a share based MIP is that any proceeds are taxed as employment income at the time of payment which will include employer NIC for the group employer (although a corporation tax deduction for the employer entity may be available which would at least soften the blow for the group).

It may also be possible to grant tax advantaged share options, which could result in proceeds being taxed as capital in broadly the same way as an upfront share acquisition. However, these share options remain rare for companies with a financial sponsor due to the restrictive conditions, the main one being that the company that issues the shares must not to be under the control of another company.

Non-tax advantaged options are a far less popular alternative. The employment tax and economic outcome for non-tax advantaged options can be very similar to a phantom share plan or cash bonus arrangement, but a corporation tax deduction is unlikely to be available. However, they do allow for employer NIC costs to be passed onto managers which is not possible with cash bonuses or phantom plans.

Set out below are the key pros and cons of alternative MIP structures.

Upfront share acquisition

MIP participant pays ‘unrestricted market value’ upfront and enters into valid ‘section 431 tax election’.

Phantom shares / cash awards

MIP participants have right to receive a cash payment on the occurrence of an exit.

Tax advantaged share options (EMI or CSOP options)

MIP participants have right to acquire shares in the future. Exercise price set at market value as grant date.

Non tax advantaged share options

MIP participants have right to acquire shares in the future for a set exercise price or for free.

Please speak to your usual Weil London Tax contact for further information.