HMRC clearly think so!

The term “founders’ shares” is not a “term of art” and does not appear in the legislation. However, it is widely used to refer to shares acquired by an individual when, or immediately after, a new company is first incorporated for the purpose of developing a new business and when the company has no value other than the capital subscribed.

Instinctively, one feels that such shares should not, as a matter of policy, be ERS if the opportunity to acquire them has been created by the individual subscribing for the shares and not made available by an existing or past employer or connected person(s).

Arguably – but so far as I am aware, it has yet to be argued before a Tribunal or court – such an acquisition is not caught by s421B ITEPA 2003 because:

• sub-section (1) does not apply because, as a matter of causation, the subscription for shares is not “by reason of” any employment, subsisting or prospective. Rather, the employment follows from and is “by reason of” the share acquisition;
• as regards the application of the deeming provision in ss(3): “employer”, as that term is used in s421B(3) is defined in s421B(8), for the purposes of the section as a whole, as the employer in relation to “the employment by reason of which the right or opportunity to acquire the [ERS] is available” and if, as a matter of fact, the opportunity was made available by the individual him- or herself and not by reason of an employment, there was no such employment, and therefore no “employer”.

(It is not possible to argue that s421B(1) does not apply for a similar reason as, on a close reading, the term defined in s421B(8) is not “employment” but “the employment”, whereas s421B(1) refers to a right or opportunity being made available by reason of “an employment”. For the purposes of ss421B(1) “employment” includes a prospective employment (s421B(2)(b)) and therefore the definition in s421B(8) is of no relevance to s421B(1).)

• the “friends & family” exclusion from s421B(3) applies because the person making available the opportunity to acquire the shares is the individual themselves and there is no more personal relationship than that which one has with oneself.

Nevertheless, HMRC guidance at ERSM20240 makes clear that, in HMRC’s view, such founders’ shares are ERS:

“Founders’ shares

It is sometimes suggested that shares are not employment-related securities because they are acquired by “founders”. There is no concept of “founders’ shares” in the legislation. The founder of a company who is to be a director of that company from the start acquires employment-related securities and is within the scope of the rules.”

Whilst, for the reasons given above, the legal basis for this is not beyond doubt, HMRC is understood to base its view on statements of Lord Hodge in Vermilion to the effect that if the opportunity for the shares to be acquired was made available by the company itself, because its directors resolved to issue the shares, that is sufficient to cause those shares to be ERS in the hands of the individuals to whom they are issued, being individuals who are then, or are intended to become, directors or employees.

Arguments to the contrary (that this does not reflect a realistic view of the facts and that HMRC’s propositions are far too broad) were rejected by the First-Tier Tribunal in Coopervision– see paras [52] – [55] and beyond. However, although they saw themselves as entrepreneurs and investors, the employees in that case were clearly not “founders” as that term is understood.

For the time being, the correct advice must be to treat shares subscribed by a founding director, or an individual intended to become a director or employee, as ERS, even if those are the only shares in issue and at the time of acquisition the company has no assets beyond the capital subscribed. This, of itself, would have no immediate adverse tax consequences if, at the time of issue, the company has no assets, as the shares would have been acquired for a consideration which was not less than their actual market value. Section 431 tax elections should be made within 14 days of acquisition but only on a precautionary basis, and the strict need for such elections would depend upon the shares counting as “restricted securities” per s423 ITEPA.

Whether such an acquisition is reportable is unclear, and the better view is that it is not. If shares are ERS only because their acquisition falls within the deeming provision of s421B(3), and not because the opportunity to acquire them was in fact by reason of an employment (or office) then it appears that the acquisition is not a reportable event (per s421K(3)(a) ITEPA).This is because section 421B applies only for the purposes of Chapters 2-4A of Part 7, ITEPA and not to Chapter 1. The application of the deeming provision does not therefore bring within the reporting requirement an acquisition which is not, as a matter of fact, by reason of employment, even it is deemed to be for the purposes of other Chapters of Part 7. The position would be different if the words in parenthesis in s421K(3)(a), namely|, “… or an event treated as…”, qualified the words “..a right or opportunity…” rather than “an acquisition”.

This view is supported by HMRC guidance at ERSM140040, as follows:

Company incorporations

Where a limited company is incorporated in the UK and initial subscriber shares (also called founder shares) are acquired

• directly on incorporation, or
• on transfer from a company formation agent, or
• from another person forming the company, for example a solicitor or accountant;

a report is not required if all of the following conditions are met:

• all the initial subscriber shares are acquired at nominal value, and
• no form of security other than shares is acquired, and
• the shares are not acquired by reason of or in connection with another employment (whether that is the only employment or one of a number of employments), and
• the shares are acquired by a person who is a director or prospective director of the company, or someone who has a personal family relationship with the director and the right or opportunity is made available in the normal course of the domestic, family or personal relationship of that person.

Company incorporations – allotment of further shares

Where a limited company has been incorporated in the UK and further shares are allotted prior to the commencement of trading or transfer of assets to the company and all of the following conditions are met:

• the additional shares are acquired by a person to whom some of the initial subscriber shares have been transferred or the person is a director or prospective director of the company, and
• the shares are acquired at nominal value, and
• the shares are not acquired by reason of or in connection with another employment (whether that is the only employment or one of a number of employments).

If such shares are allotted following the incorporation of the company it will not be reportable even if the initial subscriber shares were acquired before 5 April and the allotment of further shares is made after the 5 April.

The majority of newly incorporated companies should meet the above conditions and will not have to complete the ‘Other’ template in respect of the founder shares.

This does not, of course, mean that a chargeable event specified in s421K(3)(b)-(i) in relation to such ERS need not be reported. It must.

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