The tax implications of employment related restricted shares

Introduction.

The general rule is that securities acquired by an employee from their employer for less than market value will be taxable on that difference under ITEPA03, S62. There are exceptions for tax advantaged schemes e.g.:

a)     Share Incentive Plans (SIP's);

b)     SAYE Schemes;

c)     Company Share Option Plans (CSOP's); and,

d)     Enterprise Management Incentives (EMIs).

The general rule is that all securities obtained by an employee from the employer will be “by way of the employment” unless they are shares or securities issued purely for domestic or family reasons (and therefore not issued by reason of the employment). Therefore, all such shares will be ERS.

The above amount will also be subject to NIC and PAYE if the shares are “readily convertible assets” e.g. if the shares are in a quoted company or arrangements are in place for the shares to be sold.

Where NIC is payable, if the employee is made liable for the employer’s NIC then the amount charged to income tax may be reduced by that amount.

Anti-avoidance.

There are a number of anti-avoidance provisions which apply to shares that are subject to restrictions that affect their value. As the income tax charge is based on the market value of the securities at the time of acquisition, an employer could put restrictions in place to reduce this value e.g.:

a)     Making the shares subject to forfeiture;

b)     Restriction the disposal of the shares; or

c)     Making the shares convertible.

The 2 main types of restriction that affect the market value of shares are:

        a)     Shares subject to forfeiture for less than market value;

        b)     Shares subject to restrictions as to whom (or when) they may be sold.

Typically, income tax can arise on two occasions i.e. the acquisition of the shares and the lifting of the restrictions. Securities subject to forfeiture < 5yrs will have no tax charged on acquisition but will be taxed on the lifting of the restriction at a % of the market value at the time the restriction is lifted.

Shares subject to forfeiture > 5yrs will be taxed on acquisition at the “restricted market value” less the cost to the employee and will be taxed again on the lifting of the restriction at a % of the MV at that time (i.e. when the restriction is lifted).

Share etc subject to a restriction as to when (or to whom) they can be sold will have a depressed market value and will be taxed on acquisition on the “restricted market value” less the cost to the employee and will be taxed again on the lifting of the restriction at a % of the MV at that time.

In all cases, the % used is applied to the “unrestricted market value” at the time of lifting the restriction. This % is the % of the “unrestricted market value” on acquisition that was untaxed or unpaid on acquisition. If proceeds are received in return for the forfeit then these funds are used instead of the “unrestricted market value” at the time of lifting the restriction.

Where shares are subject to two or more restrictions, deal with each in the order in which they are lifted and apply the normal rules.

Example.

In Jan 2020, an employer awards an employee with 5,000 shares in the company at nil cost to the employee. The market value of the shares in Jan 2020 was £2.50. The shares are subject to forfeit < 2yrs. The shares end up not being forfeited and the forfeiture risk was lifted in Jan 2022. The market value at that time was £4.75. As the shares are subject to a forfeit < 5yrs there is no tax on acquisition. Tax will arise on the lifting the lifting of the restriction in Jan 2022. The percentage used is the unpaid/untaxed % of the “unrestricted market value” at the time of acquisition. Nil was paid and there was no tax charge at that time and therefore the paid/taxed % was 0% and therefore the unpaid/untaxed % was 100%. This is applied to the “unrestricted market value” at the time of the lifting of the restriction i.e. £4.75.

Capital loss.

If the employee is taxed on more value than was actually receive then the excess is treated as a capital loss and relief is available as normal.

Elections.

Elections are available i.e. S425(3) and S431 which can affect the tax due. These elections are joint elections (employer and employee) and must be made < 14 days after  “acquisition” and are irrevocable. There is not need to report the election to HMRC.

The S425(3) election disapplies the < 5yr rule and therefore gives rise to “acquisition tax”. This reduces the “lifting tax” untaxed % and reduces the “lifting” tax. This is beneficial if values increase but “acquisition tax” paid can’t be recovered if prices fall.

A S431 election ignores all restrictions and taxes the URMV on “acquisition” only and therefore there is no tax on the lifting of the restrictions. It will be beneficial if shares are not forfeited and values increase. A S431 election will be beneficial if shares are not forfeited and values increase.

The 14 day rule and the irrevocable rules mean that a “wait-n-see” approach is not allowed.

Where there is > 1 restriction a S431 election can be made to ignore all of them or only “specified restrictions” – the normal rules would then apply to the others.

Option.

In the case of an “option”, as normal, there is never a tax charge on the acquisition of an “option” and this rule also applies to a “restricted option”. Any tax charge is calculated in line with the above rules and the RMV on “exercise” of the option is used for the “acquisition” value and the “lifting tax” works as normal i.e. based on the URMV on “lifting”. A S431 election can be made.

EMI.

If the “restricted shares” are also EMI shares then the above rules will only be relevant if there was a discount on “grant” as there is no tax on “exercise” otherwise. The EMI discount would be RMV on “grant” (capped at RMV on exercise) less cost. However a S431 can be made to use the URMV as per the above!

Base cost.

The “base cost” for CGT is as per normal i.e. cost plus the amount taxed as employment income. The S431 election effectively moves income to capital and typically this is beneficial due to lower rates. Business Asset Disposal Relief may also be available if the conditions are met.

Reporting.

A return must be filed with HMRC by the employer by 06 July following a tax year in which there was a “reportable event” e.g. acquisition, lifting of restrictions or any other taxable event.

Exchange.

Where “restricted securities” are wholly exchanged for new “restricted securities” then that is not a “chargeable event” and the normal rules above apply to the new shares as they did to the old shares.

An S425 or S431 election can’t be made for the new securities but if there         was one already in place for the old securities then it will roll-over onto the new securities.

Full relief i.e. the exchange is not a chargeable event at all, is available only if the value of the new securities </= the value of the old securities and the new shares must also be “restricted securities”. If full relief is not available then the exchange is treated as 2 disposals i.e. part simply rolls-over onto the new securities and part is a “chargeable  event”.

Disclaimer.

The above is only intended to be a broad general overview of some of the rules in this area and is not intended to be taken as advice. Although care is taken, errors and omissions can occur and as the facts of each case is very important, expert opinion should always be obtained before arriving at a decision. If you would like any additional help or guidance then please do not hesitate to contact us.