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taxadvisor.uk
taxadvisor.uk, Chartered Certified Accountant
Category: Tax
Satisfied Customers: 4983
Experience:  FCCA - over 35 years experience as a qualified accountant (UK based Practitioner)
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I have a small business consultancy company owned 50:50 with

Customer Question

I have a small business consultancy company owned 50:50 with my wife. Revenues to date are <VAT threshold. One big project is now nearing completion. In lieu of fees, the client has given my company the right to require equity warrants to be issued over a number of shares of the client company, with an exercise price equal to the nominal value of the shares. The client company is shortly to be sold, and the value of the warrants would take my company over the VAT threshold. Is the warrant arrangement VAT-able? If so, presumably on exercise of the warrants? In which case how do we charge the VAT to our client?
Submitted: 1 year ago.
Category: Tax
Expert:  taxadvisor.uk replied 1 year ago.
Hello and welcome to the site. Thank you for your question.

Please clarify for me .. what happens if you don't exercise the warrants?

As I see it, the customer company wishes to grant you shares in lieu of payment. The money worth is still a taxable supply in your books and subject to VAT if you reached the threshold for VAT registration. The warrant arrangement is mode of payment but the work done is VAT-able.

If you think you are going to exceed the threshold, then you should register for VAT and any invoices raised from date of registration would be subject to VAT. You should then raise the invoice to customer for work done and charge VAT on it. How it is settled is irrelevant for VAT purposes as it would be payment/arrangement to clear debt.

I hope this is helpful and answers your question.

If you have any other questions, please ask me before you rate my service – I’ll be happy to respond.

Customer: replied 1 year ago.

Thank you. The warrants have a 5 year life; if I do not exercise them during that time, they will expire. I entirely follow your logic. My issue now is, what is the monetary amount on which the VAT is due? The warrants will be over 305 shares, being 2% of the share capital, and the exercise price per share is the par value (£1 per share). One possibility, I assume, is therefore 305 x £1 = £305. Clearly, if this were the case, we would be nowhere near the VAT threshold. However, I doubt HMRC would accept as it takes no account of either the time value or the intrinsic value of the warrants. Alternative 2: use some kind of deemed market value. Tricky because the client company is an unlisted, private company whose sole purpose is to hold IP: it does not trade commercially, so there are no traditional metrics to use for valuation. The only recent meaningful fundraising is a rights issue to the existing shareholders, just completing now, underwritten and subscribed at £150/share (1,000 new shares being issued). On this basis, the value of the shares into which the warrants would exercise is 305 x £150 = £45,750, which gets us closer to the threshold. Just to be clear, although I said in my previous message that the company is to be sold, as things stand today there is no offer and consequently no bid price that could be used. Very interested to hear your view on this!

Expert:  taxadvisor.uk replied 1 year ago.
Richard, thank you for your reply and for additional information.
I am away from my desk and will revert to you in the morning.
I hope this is acceptable.

Many thanks
Expert:  taxadvisor.uk replied 1 year ago.

Richard, thank you for your patience. Here are my views:

Thank you. The warrants have a 5 year life; if I do not exercise them during that time, they will expire. I entirely follow your logic. My issue now is, what is the monetary amount on which the VAT is due? The warrants will be over 305 shares, being 2% of the share capital, and the exercise price per share is the par value (£1 per share). One possibility, I assume, is therefore 305 x £1 = £305. Clearly, if this were the case, we would be nowhere near the VAT threshold. However, I doubt HMRC would accept as it takes no account of either the time value or the intrinsic value of the warrants.

My view -

There is a commercial value of time and effort applied on this project. You must have agreed some terms and conditions and project price at the outset. If you decide to waive that price that is your commercial decision as this would reflect on your overall income and profit. The company has given you the right to acquire equity warrants in lieu of cash. It could be because the company has cash flow issues.

The question is … If you were to turn down the right to acquire equity warrants, would the company pay you for your services or would you have to take a hit in some loss of income?

If you decide to invoice the company £305 for services rendered, there is little HMRC can do about it as it is a commercial decision and you accept the warrants as payment. This invoice value would be your turnover for VAT threshold purposes also.

The exercise of these warrants would make it capital investment in the company and potential capital gain on sale of those shares in due course. You are sacrificing real income for potential capital gain.

Alternative 2: use some kind of deemed market value. Tricky because the client company is an unlisted, private company whose sole purpose is to hold IP: it does not trade commercially, so there are no traditional metrics to use for valuation. The only recent meaningful fundraising is a rights issue to the existing shareholders, just completing now, underwritten and subscribed at £150/share (1,000 new shares being issued). On this basis, the value of the shares into which the warrants would exercise is 305 x £150 = £45,750, which gets us closer to the threshold.

My view -

I would not consider this option … how long is the piece of string!!!!!

If you raise an invoice on some kind of deemed market value and the value fails to materialise when it matters, you have egg on your face and a massive capital loss where as you would have paid income tax on your profits. I am being pragmatic.

Just to be clear, although I said in my previous message that the company is to be sold, as things stand today there is no offer and consequently no bid price that could be used. Very interested to hear your view on this!

My view –

My question to you is - are you risk averse?

A risk averse investor is an investor who prefers lower returns with known risks rather than higher returns with unknown risks.

I would rather have income for work done and pay my taxes than invest something like £45k in equity warrants where certainty is in question.

I hope this is helpful and answers your question.

If you have any other questions, please ask me before you rate my service – I’ll be happy to respond.

Customer: replied 1 year ago.
Thank you for very useful advice. I am comfortable with the commercial decision to take my compensation in the form of warrants: to use your language, I have a tolerance for risk in this situation because the upside is potentially very considerable. I should have mentioned that the client company is offshore (Cayman) with management offices in Guernsey: does this is have any relevance as regards VAT?
Expert:  taxadvisor.uk replied 1 year ago.
Richard, thank you for your reply.

If the service is provided from the UK to the customer based outside the UK the service is zero-rated for VAT purposesand are excluded from calculating VAT threshold.

If you are happy and there are no more issues I will appreciate if you would kindly rate/accept the service I provided to ensure I get credited for it by Just Answer.

.
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Customer: replied 1 year ago.
Thank you very much indeed for excellent, clear advice.
Expert:  taxadvisor.uk replied 1 year ago.
I thank you for accepting my answer.
Your reward of a bonus is greatly appreciated.

Best wishes.