Restricted securities explained
Jonathan Harvey · May 25th 2023 · read
In this insight we will be shedding some light on the restricted securities legislation, and what this could mean for your business and employees when it comes to selling shares that you thought would be 100% capital gains taxable.
Securities fall within the restricted securities legislation if they are:
- includes shares, debentures, loan stock and financial instruments such as options, futures, contracts for differences and rights under contracts of insurance.
- which are employment related,
- acquired by an individual through a right or opportunity available by reason of their employment. If made available by that individual’s employer or a person connected to their employer, then it is automatically deemed to be by reason of their employment.
- acquired on or after 16 April 2003 (the legislation wasn’t introduced until that date), and
- have restrictions attached.
- These essentially depress the market value, and can include:
|Reason for restriction||Example|
|Forfeiture||An employee receives shares but would forfeit them if they left the company within a set period.|
|A limit over the rights||An employee is not allowed to sell the shares until they have held them for a period, or they may never be able to sell them.|
|Any other disadvantage||An employee is required to leave their employment on selling their shares.|
What is a depressed market value?
The market value essentially looks at a hypothetical sale on the open market with a willing buyer and seller. But where securities are restricted, this definition isn’t applicable because restrictions are ignored for capital gains tax purposes. This is the unrestricted market value (UMV).
For restricted securities, personal restrictions applying to the shares will need to be considered to work out a value. This will then potentially reduce the market value of the shares resulting in an actual market value (AMV). If these two values are different, then this would indicate that the security is restricted.
We also see this regularly with our unlisted corporate clients where the articles of association include restrictions which can, in HMRC’s view, reduce the market value. The amount of reduction is subject to interpretation. HMRC tend to view it at around 10% however in some very unusual circumstances this could be up to 20%.
Valuing securities can be a complex task which we would not advise undertaking alone. Our corporate finance team are ready to assist with your valuation questions and can provide robust methodology to support valuations for your securities.
The business impact
The problem comes where these two values are different. On acquisition the employee has received value from their employer and any amounts up to this value which have not been paid for should be taxed as employment income.
Although tax will ultimately need to be paid on the full unrestricted market value, the legislation only requires this tax charge to be calculated based on the actual market value of the shares at acquisition. So, if there is a difference between the actual and unrestricted market values, then there is an untaxed percentage which eventually must be charged to employment income tax and possibly NIC – see below.
If a chargeable event occurs, then this untaxed percentage comes back into play but is based on the unrestricted market value at the chargeable event date. If the business has grown since the acquisition date, then the value of the shares could have increased dramatically, and the income taxable amount may then be significant (hundreds of thousands of pounds not pennies if the company has grown dramatically). Chargeable events are broadly the securities no longer being restricted, variation of a restriction, or sale of the securities.
If the shares are listed by the time of the chargeable event or the business is going through a sales process at that time for example, then the shares would be considered ‘readily convertible assets’ at that time, which generally means they can be easily and quickly exchanged for cash. This would mean any income taxable amounts are also liable to class 1 NIC, payable both by the employer and employee, and the income tax and NIC would be payable via PAYE.
This can be very expensive for the shareholders and company.
The potential solution
An election can be made by the company and the employee to calculate any amounts chargeable on acquisition based on the shares’ full unrestricted market value instead. Therefore, there will be no untaxed percentage which will still need to be charged to employment income later, and any increase in the value of the shares will be subject to capital gains tax at the much lower rate of 20% rather than at income tax and NIC rates of up to 47% combined.
This election must be made jointly by the employer and employee within a short 14-day time limit after the shares are acquired, so it is best to take advice in advance of implementing any share schemes. Not making an election can be extremely costly!
This said, it is never too late to review the tax implications for any employment related securities that you may have. At MHA, we have worked with clients across a range of advisory projects, including implementing share schemes and other employee incentivisation plans, due diligence exercises, takeovers and business sales, internal restructuring, or we can work with you to consult with your employees on their individual tax implications. We can also advise on the compliance requirements around employment related securities, in addition to payroll mechanisms for the deduction of taxes for employees in receipt of the securities.
If you would like to know more about restricted securities, or to discuss any share related matters for your business and your employees, please get in touch below.