Insights

Updated: 7th February 2024

When shares are being transferred or issued to employees or officers of a company, it is common practice for the acquiring shareholder and a company officer to be advised to sign a section 431 (s431) election, within the 14 day deadline for doing so.

Why have a section 431 election in place?

This is a regular part of the forward tax planning process, and the tax benefits can be significant. A s431 election will help to minimise the amount of tax payable on gains made on company shares when they are sold. For employees and officers acquiring shares in the company that employs them, it is an important piece of paperwork to have in place. It is also an important piece of paperwork for a company to have in place in the event of a share sale.

Section 431 elections become easier to access

HMRC updated its guidance concerning s431 elections on 19 July 2022 and has made the process of obtaining one more straightforward. The changes are as follows:

• S431 elections can now be entered into through a variety of formats other than HMRC's standard form (provided there is evidence to demonstrate that both the employee and the employer have agreed the key terms in sufficient detail);
• Elections can be incorporated into other documentation (e.g. a subscription agreement) and can be agreed via email;
• If a national insurance number is not available for the shareholder at the time a s431 election is made, it will not affect its validity;
• S431 elections can now cover more than one type of security issued by more than one company at the same time, but they must have been issued by companies within the same group structure (if applicable).

Important to retain records

It is important to retain clear records of any s431 correspondence. HMRC may request evidence that s431 elections were made and that they were made within the 14 day deadline following the share issue or transfer, so companies and individuals should retain their s431 election documentation in a form which can be verified by HMRC.

Understanding s431 Elections

What is the ‘employment related securities’ legislation?

Special tax rules apply to the issue of employment-related securities. These affect all employees and officers of companies (whether they are executive or non-executive and are current or former employees); who either subscribe for, or acquire shares in either the company they work for directly, or a company that forms part of a group of companies for which they work.

The employment related securities legislation can also impact investors who are subsequently appointed as company directors or employees. They exist to ensure that any income arising from shares is not taxed as capital when it should properly be taxed as income in the view of HMRC.

One of the unacceptable ways HMRC identified of ‘converting’ income into capital (thus ensuring it was taxable at lower tax rates) was the practice of giving employees or officers restricted shares in a company which had a value which was, at the time they were issued, suppressed by virtue of restrictions attached to them. The restrictions would typically be documented in articles of association or shareholder / investor agreements and would either fall away or be removed at a later date, leaving the employee with a much more valuable asset than they had originally purchased, and therefore a large capital growth.

The employment related securities legislation provides that in such cases, a percentage of the capital growth is charged to income tax rather than capital gains tax.

The difficulty is that, even inadvertently, on more occasions than not, employment related securities will have restrictions attached to them; the most common being the requirement for a director/ employee to sell their shares back to the company or to existing shareholders, should they leave the employment of the company.

This means that the shares automatically fall within the employment related securities legislation, and on a disposal, the gain will, in part, be subject to income tax at a potential rate of 45%, rather than capital gains tax at a potential rate of 10%.

How are employment related securities valued?

When employment related securities are issued they have two different values:

• The Actual Market Value (AMV) – this is what the shares are actually worth with restrictions attached; and
• The Unrestricted Market Value (UMV) - what the shares would be worth without any restrictions attached – where there are any restrictions this will always be higher than the AMV, unless the shares are issued on a company incorporation.

Provided the officer or employee pays the full UMV for their shares as at the time of their acquisition and makes a joint election within 14 days to say they have done so (the s431 election), they will not be required to pay an income tax charge on the future growth in the value of the shares when they are eventually sold.

The broad purpose of the election is therefore to confirm that the shares have been acquired at a price equal to their unrestricted market value, and not at a discount because of the restrictions attached.

Example: the employment related securities income tax charge

Greener Grass Ltd wishes to issue shares to Samantha, a new company director, as part of their total remuneration offering. These shares can only be sold by Samantha if at a future point in time the company is sold to a third-party investor. At the time these shares are awarded to Samantha, their AMV is £1.50 and their UMV is £2.00.

Samantha pays £1.50 per share, however, the UMV of the shares is documented as £2.00, so when the shares are finally sold as part of a third-party purchase, Samantha will pay capital gains tax on ¾ of the gain, and income tax on ¼ of the gain.

Benefits of a s431 election

If Samantha pays £2.00 per share and makes a joint s431 election to confirm that she has paid UMV for the shares, none of the future growth will be chargeable to income tax. Alternatively, she can pay £1.50 per share (or less) and pay income tax now as a benefit in kind on the difference between £2.00 per share and the £1.50 per share that she pays, and provided she makes a joint s431 election, this will have the same effect.

If you have any questions regarding employment related securities, share transfers, s431 elections or establishing employee share schemes, please email us via partners@rjp.co.uk

HMRC Employment Related Securities Manual