This is a question that comes up often for staff who are being offered an equity stake in their company, and it revolves around the taxation of future growth in the value of the shares.
It is common for shares to come with rules attaching to them which restrict their transfer by the person receiving them in order to protect the commercial interests of the owners. For instance, most owners will want to include restrictions on an employee’s ability to transfer or sell the shares, which will have the effect of reducing the amount that they could be sold for compared to if they could be freely dealt with. This “devaluation” of the shares was exploited in the past by companies including restrictions to reduce the amount of income tax that employees had to pay when receiving shares (as that tax bill is based on the value of the shares). The restrictions could later be released, and no further income tax would be payable, with any eventual profit being taxed at the lower capital gains tax rates. Some years ago HMRC legislated against this by imposing an income tax charge on the increase in value when the restrictions were released, or the shares were sold.
This is where the S 431 election comes in. If the election is made at the outset, the income tax charged to the employee on receipt of the shares is based on the unrestricted value of the shares at that point, not the actual value after taking the restrictions into account. This does of course mean that the upfront tax charge will be increased, but the benefit of the election is that when the shares come to be sold, the whole of the increase in value over the period of ownership is subject to capital gains tax. If the election is not made, HMRC can charge income tax on a proportion of the increase in value based on the difference between the upfront actual and unrestricted values as shown in the following example:
|
Actual value of shares at date of acquisition |
£4,000 (A) |
|
Unrestricted value of shares at date of acquisition |
£5,000 (B) |
|
Increase in value to date of sale |
£100,000 |
|
Amount subject to capital gains tax |
£100,000 x A/B = £80,000 |
|
Amount subject to income tax (balance) |
£100,000 x A-B/B = £20,000 |
In the example, an upfront payment of additional tax on £1,000 when making the S.431 election will have resulted in an eventual saving of additional tax on £20,000 on sale.
The question then is “how do we know how much the actual and unrestricted values are at the date of receipt” of the shares? There is no process for agreeing this value with HMRC at that point, so it is necessary to obtain an expert valuation on both bases for the employer to disclose to HMRC on their annual return, which is unlikely to be challenged at that point and will therefore be taxed on the individual shareholder who will need to enter either the unrestricted or actual value on their self-assessment tax return, depending on whether the election has been signed or not.
If the election is made, it needs to be signed by both the employer and the employee and this must happen within 14 days of receipt of the shares. There is no requirement for the signed form to be submitted to HMRC on issue of the shares, it just needs to be kept safely in case it is required in future to justify a claim for capital gains tax treatment for the whole of the sale proceeds.
Author: Mark Horsfield, Business Services Manager, Plus Accounting
Any views or opinions represented in this blog are personal, belong solely to the blog owner and do not represent those of Plus Accounting. All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.
Date Published: 02 May 2023