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Paying for services with shares: how it works and what it means for taxation

Sometimes companies offer to pay for services with shares. If you’re a startup, paying with shares is a way to get new investors and business partners on board without affecting your cash flow. For the person providing the services, it gives them the opportunity to become an investor in your business and benefit from the potential upside if and when your business becomes successful.

While it’s legal to pay with shares, there are some tax and regulatory issues that both you and the person receiving the shares need to be aware of. It’s worth noting that paying with shares is not the same as giving someone an option to purchase shares in the future. When you pay with shares you’re actually making that person a shareholder.

In this article, we outline what happens when you give someone shares for services.

Your business needs to have enough shares to give

If you want to bring on board a new shareholder, your business has to have enough shares to give them. There are two ways you can do this without changing the value of the company:

  • Complete a share split.
  • Have an existing shareholder transfer part or all of their shares to the new shareholder.

A share split is when you divide the shares you have into more shares without increasing the value of the company. Every shareholder in the company will receive more shares from the split but the value of each share will reduce. So if you had 100 shares valued at $1 each, after the split you may hold 200 shares but they’re valued at 50c each. The total value of the shares you hold is the same but the number of shares you own is different.

The opposite of a share split is a share consolidation. This reduces the number of shares in the company without changing its overall value.

If you are completing a share split (or consolidation), you will need to follow several steps:

  • The shareholders must unanimously pass a resolution for the share split or consolidation. The resolution should outline exactly how many new shares there will be, their value, and the date of the share split or consolidation.
  • The share register must be updated. This must include the number of shares issued, the date they were issued, the shareholder’s name and address and whether the shares are beneficially held or not.
  • New share certificates need to be issued and the existing ones will then need to be destroyed.
  • A Form 2205 should be completed and sent to ASIC within 28 days.

It’s also important to put an agreement in place between the company and the new shareholder that outlines the terms of the share issue and the consideration provided.

If one shareholder is transferring their shares, you will need to:

  • Check the Shareholders Agreement and Constitution to make sure you can complete the transfer. The shareholders may need to pass a resolution or the board may need to approve the transfer first.
  • Put in place an agreement between the shareholder and the person receiving the shares that outlines how the sale will occur and what each is entitled to.
  • Complete the share transfer with ASIC.
  • Issue a share certificate to both shareholders and destroy the original share certificate for the transferring shareholder.
  • Update the shareholder register.

Both parties need to bear in mind the taxation consequences

Regardless of whether you’re paying in shares through a share split or a transfer, there may be taxation consequences for the company, the person transferring shares and the person receiving them.

From the company’s perspective, Taxation Ruling 2008/5 explains the tax implications when shares are issued for services. The value of the shares may not be deductible for tax purposes under section 8-1 of the Income Tax Assessment Act 1997 (Cth). If the company had paid for the person’s services with cash then they may have been able to get a tax deduction for the payment.

Because the shares are issued for non-cash consideration, the company must also show ASIC that they have paid any stamp duty required by the relevant state or territory. This means they must complete a Form 207Z that states that stamp duty has been paid on the written contract between the company and the new shareholder. If you don’t have a written contract that outlines how the shares were issued for non-cash consideration, then Form 208 must be completed, which notifies ASIC that shares have been issued for something other than cash.

The person receiving the shares may also have tax consequences. If someone is being paid in shares for work completed then the shares may be considered to be income for tax purposes. Even if the shares are not available on the open market, their value for tax purposes would be the arm’s length value at the time the shares are issued. It can be difficult to work out the market value of the company. Ideally, it would be what a third party is willing to pay for the shares, but if your company is a startup that has no revenue this may be close to $0. In that case, a nominal amount may be sufficient but this may be challenged by the Australian Taxation Office.

When the individual sells their shares, however far in the future that is, they may be subject to capital gains tax. That means that they may need to include in their assessable income the difference in the value of the shares at the time they received them and the sale price.

If the shares are transferred from one shareholder to another, the person transferring the shares may also be subject to capital gains tax.

There are also specific tax rules for employees who receive shares for service often called employee share schemes. These are contained in Division 83A of the Income Tax Assessment Act but they only apply to people who are employees and receive shares at a discount to market price. In the situation outlined here, the new shareholder is not an employee so this won’t apply.

When you pay for services with shares, it triggers some complicated provisions in both the corporations and the taxation law. It’s important to seek legal, tax and accounting advice when contemplating transactions like these.

If you’d like to know more get in touch with CCASA for information about how we can help you.