Normally, an award of shares to an employee or director would be liable to both income tax and national insurance (NIC) based on the market value of the shares at the time that they are exercised.
In the past, to mitigate costly income tax and NIC, an employer might place restrictions on shares to suppress their value, which would subsequently either fall away or be removed, leaving the employee with more valuable shares. The uplift in value would then be liable to the more favorable capital gains tax (CGT) rates when the shares are eventually sold.
Indeed, most share awards will include restrictions, which will lower the market value of the shares, for example:
- Good and bad leaver clauses;
- Employee performance conditions;
- Lock-in period for the employee; and
- Restrictions on voting, or dividends, until the shares vest
To counter any disparities, the restricted securities regime (RSR) introduced the concept of restricted value, as follows:
- Actual market value (AMV) – what the restricted shares are worth
- Unrestricted market value (UMV) – what the shares would be worth without restrictions. This will always be higher than the AMV.
The RSR stipulates that unless the employee pays the UMV at the time that the shares are acquired (or makes a s.431 election), the percentage difference between the UMV and AMV at the time of acquisition will be treated as income (up to 45%), rather than capital (up to 20%).
For example, if the percentage difference between the UMV and AMV was 25%, then 25% of the disposal proceeds would potentially be liable to income tax.
The s.431 election effectively accelerates the tax charge on acquisition of the shares on the difference between the AMV and UMV. This is achieved by ignoring some or all of the restrictions placed on the shares and treating them as being acquired at their UMV.
Both the employer and employee should sign the s.431 election within 14 days of the share acquisition, though it could be completed at an earlier date (i.e. when the option over the shares is granted). The election is irrevocable.
There is no need to send the signed s.431 election to HMRC, though it should be included in the company’s Employment Related Securities return by 6 July following the tax year in which the taxable event took place.
Generally, the s.431 election is beneficial though the following should be understood:
Employee
If the share value increases, the s.431 election will tax the growth at CGT rates – generally lower than income tax rates. However, if the shares lose value, the election will mean that the employee will have paid more tax than they would have had the election not been made. Furthermore, if the shares are forfeited due to the employee leaving the company, then tax will have been paid on a benefit that was not received.
It is not possible to claim an Income Tax and NIC refund if the election is made, and the share value later goes down or if shares are forfeited, so this risk must be considered prior to making the election.
Company
NIC will be the key consideration for the company when deciding if the s.431 election is beneficial.
NIC would only be charged if the shares are Readily Convertible Assets (i.e. they are capable of being sold on a recognized stock exchange), which is more likely at the time of sale, than at acquisition.
The election can provide a NIC advantage when the share value increases, as the charge will typically be less on the difference between the AMV and UMV on acquisition, than if paid on the same proportion when the shares are eventually sold.
What next?
If you have any questions or would like assistance please contact our Gravita experts, who will be happy to provide more detailed advice.
