On 19 July 2022 HMRC published a helpful and welcome update to its Employment Related Securities Manual relating to restricted securities elections (Restricted Securities Elections). The law in this area is complex and full of pitfalls for the unwary and anyone who has been through a transaction involving UK employee or director shareholders will be (for better or worse) familiar with Restricted Securities Elections, also commonly known as ‘431 elections’ (although they do have a lesser known cousin, the ‘430 election’).
In summary, a Restricted Securities Election permits a UK employee or director and their employing company to jointly elect to accelerate a UK employment tax charge in relation to employment-related shares and other securities. The purpose of doing this is to pay employment tax (including income tax and National Insurance contributions) calculated by reference to the value of the shares at the time of acquisition, which, assuming that the shares or securities rise in value over time, should be more efficient. Making the Restricted Securities Election, which must be done within 14 days from acquisition of the relevant shares or securities, means that any increase in the value of the shares or securities after acquisition should be outside of the employment tax regime and instead subject to capital gains tax at a lower rate (and subject any other applicable tax rules). This is a simplification and the outcome is not always straightforward.
Although relatively uncommon, in particular in relation to private company shares, employees and employers sometimes choose not to make a Restricted Securities Election, thereby deferring any employment tax to a future date. In such a case, employment tax may not only arise when the shares and other securities are sold, but also at various points along the way, such as when restrictions attaching to the shares or securities fall away. The advantage of this is to avoid paying employment tax on a higher value. In other words, if the shares fall in value after acquisition then deferring the tax should, in the absence of a Restricted Securities Election, be more efficient. Alternatively, this approach may be taken to address payment issues if there is no cash available to fund the upfront employment tax. Of course, if employees pay full market value for shares or securities upfront (also known as ‘unrestricted market value’), there is no downside to making the Restricted Securities Election.
Although largely confirmatory in nature, the updates published by HMRC contain some useful practical points, as follows:
- Restricted Securities Elections can be made in a form other than that published by HMRC, can cover more than one type of security issued by more than one company (provided all issuing companies form part of the same corporate group) and can be signed on behalf of the employee under a power of attorney. This is of particular relevance for employee share arrangements involving a high number of participants or multiple types of securities, as well as for buyouts with several ‘rollover’ steps at completion.
- Restricted Securities Elections can be signed electronically and/or as part of another document (e.g. a share subscription agreement or application form) provided the same level of detail as the corresponding HMRC example form is included.
- The validity of a Restricted Securities Election is not affected if the employee or director making the election does not have a UK national insurance number. This often comes up if the employee or director has recently moved to the UK.
Notwithstanding these clarifications, which do not have force of law but are a strong indication of how HMRC applies the law in practice, it is best to follow the HMRC prescribed format for a Restricted Securities Election unless there is a good reason not to. Any deviations should reflect what HMRC considers are acceptable in its updated published guidance.
It is interesting to note that in October 2020, the Office for Tax Simplification issued a recommendation as part of their ‘Claims and elections review: Simplifying administrative processes’ report that Restricted Securities Elections should be reversed so that the tax treatment currently obtained by making a Restricted Securities Election is the starting point, and that if an employee and employer wish to defer an employment tax charge until a future event, they should be required to make an election. This certainly seems more logical and would simplify the process even further, but we understand a response has not yet been received from the government.
Finally, it goes without saying that making – or not making – a Restricted Securities Election can have a material impact on the tax treatment of shares and securities held by employees and directors, so advice should always be obtained before doing so. In addition, the commentary above relates to the UK tax position only; any employees or directors, and employing companies subject to tax outside the UK should always consider their local tax positions too.