Sweat equity – the tax implications

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Many start-ups don’t have the cash available to remunerate key individuals appropriately for their contribution in developing a business from ground level. Instead, it is commonplace to see arrangements for unpaid hard graft in exchange for a share in the business’ future – most commonly some share capital if the venture is successful. Most often done on trust between acquaintances.

Many business owners don’t have it high up on their list to address the tax issues that may arise from these type of arrangements. HMRC have in place various tax favourable schemes to make these arrangements tax beneficial for employees, and the most benefit is achieved if the schemes are set up at a time when the company value is low.

Increasingly the relative/friend/ previous business colleague may not be on the payroll or may be a contractor – anyone who is not an employee has been left out of the picture when it comes to special arrangements.

For non-employees it is vital to document any sweat equity arrangements appropriately while the value of the business is low. This sets in stone the value of the exchange of labour for equity at that time. Otherwise the labourer’s reward, when given at a time when the company is worth a whole lot more, may be bitter sweet – an illiquid shareholding together with a hefty tax bill from which there is no cash to pay it. That’s not the best way to say thank you.

Larger tax advantages of formal share schemes, or any sweat equity arrangement, are achieved when they are formalised whilst the company has a low value. This is also the time when you are busy dealing with other things. If you would like some advice on shares schemes or documenting sweat equity arrangements appropriately, please contact Ellis & Co accountants in Chester to find out more.

Call us today on 01244 343 504 or email info@ellis-uk.com.