Restricted securities and section 431 elections are particularly important where employees, directors or founders acquire shares subject to restrictions that depress their value at acquisition but may disappear later. The election can accelerate Income Tax onto the unrestricted value of the shares when they are acquired, potentially preventing a further employment-income charge when restrictions are subsequently lifted.
The decision is therefore a trade-off. Paying tax on a higher value at acquisition may be advantageous where substantial future growth is expected, but it can expose the employee to tax on value that is never ultimately realised if the company performs poorly.
How restricted securities and section 431 elections interact
Restricted employment-related securities can include shares subject to forfeiture, compulsory transfer provisions, restrictions on sale, limited voting or dividend rights, or arrangements that prevent the holder from obtaining full market value.
Without an election, the initial employment-income charge normally reflects the actual market value of the shares taking those restrictions into account, less any amount paid by the employee.
The difficulty arises when a restriction later lifts, changes or disappears. That can constitute a chargeable event and create an additional employment-income charge calculated by reference to the unrestricted market value at that later time.
The current restricted securities chargeable-event rules recognise the lifting or variation of restrictions and certain disposals as events capable of producing further employment income.
Restricted securities and section 431 elections within 14 days
A section 431 election changes that treatment by allowing the employee and employer to elect to ignore restrictions when determining the initial taxable value.
A full section 431(1) election ignores all relevant restrictions. The employee is effectively taxed by reference to the unrestricted market value at acquisition, less qualifying consideration paid, and future Chapter 2 charges arising from the lifting of those restrictions are removed.
A section 431(2) election can instead ignore specified restrictions while leaving others in place.
The section 431 election conditions require the election to be made jointly by the employer and employee, in an HMRC-approved form, no later than 14 days after acquisition. The deadline is statutory and should be treated as part of the share-issue process rather than something to consider when the annual tax return is prepared.
HMRC’s guidance confirms that an election can also be signed before the shares are acquired, which is often preferable where a transaction timetable is known in advance.
The unrestricted market value must be supportable
The tax decision cannot be separated from valuation.
Actual market value reflects the restrictions attaching to the shares. Unrestricted market value broadly considers what the shares would be worth if the relevant restrictions were ignored. The difference between those values determines the economic cost of making the election.
For an early-stage company, assume an employee pays £10,000 for restricted shares with an actual market value of £10,000 but an unrestricted market value of £25,000.
Without a full election there may be no initial employment-income charge if full actual market value is paid, but a later employment-income charge can arise as restrictions fall away.
With a full section 431 election, the employee may instead be charged to employment income on £15,000 at acquisition. Future growth attributable to lifting the elected restrictions is then removed from the Chapter 2 employment-income regime.
This can be attractive where the company’s value is expected to increase rapidly, but the upfront tax cost is real.
PAYE and National Insurance may also arise
Where shares are readily convertible assets, an employment-income amount arising on acquisition can bring PAYE obligations for the employer, with National Insurance potentially applying as well.
The company therefore needs to establish the share value, election position and payroll treatment before completion rather than leaving the issue solely to the employee’s Self Assessment return.
For founders and employees in private companies, the difference between market value and unrestricted market value can be significant and should ideally be supported by a contemporaneous valuation.
The later sale moves into the capital gains regime
Amounts already charged to Income Tax under the employment-related securities rules can affect the acquisition cost used when a later capital gain is calculated. The rules are designed to prevent the same economic value being taxed once as employment income and again as a capital gain.
That does not mean all future growth becomes tax-free. Once the employment-related securities charges have been dealt with, subsequent growth can still form part of the Capital Gains Tax computation on disposal.
Employees expecting to sell shares should therefore reconcile the original purchase price, amounts previously subjected to Income Tax and the eventual disposal proceeds within the appropriate Capital Gains Tax calculation.
Where restricted shares are issued to founders, directors or key employees, specialist tax advice should address the valuation and election before the 14-day deadline expires.
Disclaimer: This article is provided for general guidance only and does not constitute personal tax, legal or financial advice. The correct tax treatment depends on the specific facts, applicable legislation and HMRC practice at the relevant time. You should contact us for advice tailored to your circumstances before taking or refraining from any action.
