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Tax Bite – Section 431 Elections

In this Tax Bite, we give you a refresher on section 431 elections, with a focus on practical points and tips for transactions.

Background – what are s431 elections and what do they do?

Almost all shares acquired by a director (including a non-executive director) or employee of a company (or anyone connected with any such person) will be employment-related securities for tax purposes, bringing them within the scope of a wide array of income tax anti-avoidance rules.

One of those sets of rules is around “restricted securities”. The regime applies where shares are acquired that are subject to restrictions on the freedom to sell the shares, or on the rights attaching to the shares, and the value of the shares acquired is less than it otherwise would be due to the restrictions. A classic example would be good leaver / bad leaver forfeiture provisions.

Under the restricted shares regime, unless either (or indeed both):

• the employee paid the full “unrestricted” market value (“UMV”) upon acquisition of the shares; or
• a s431 election is made on acquisition,

then the proportion of the gain made on the shares that relates to the effect of the restrictions at the outset will be subject to income tax rather than capital gains tax when the employee later sells the shares (or, less commonly, when the restrictions are lifted).

The s431 election is an election to ignore the effect of the restrictions at the point of acquisition, so any income tax on acquisition is on the difference (if any) between the price paid and UMV. The election takes the shares outside of the restricted share regime on any subsequent event, e.g. sale.

The election is made jointly between the employer and employee and must be made within 14 days of acquisition of the shares. Elections are ineffective if made later. They do not have to be submitted to HMRC, but should be kept safe to produce as evidence later.

Making a s431 election is a matter of choice, but usually to be recommended. Buyers will want to see them when purchasing a company, to be comfortable there will be no PAYE and NIC charges under the restricted shares regime when they acquire shares from employees and directors. For the employee, as noted above electing means there is no risk of an income tax charge under the restricted share rules on sale, on what could be a large sum of money depending on the value of shares by the time of sale and what (if any) discount to UMV the shares were initially acquired for.

Practical points and tips for s431 elections

• Include them as a matter of course in document lists and completion deliverables for transactions, whenever shares are being acquired by employees or directors, e.g. on the exercise of an option (i.e, have them made on completion not “within 14 days”).
• Don’t forget them on other share acquisition events e.g. if options are being exercised outside of an exit, or shares are being directly subscribed or acquired by employees / directors.
• There is no downside in making an election that technically has no effect, for example because the shares are not actually restricted, or UMV is in fact already being paid – better to be safe than sorry.
• There is a rule deeming an election to be made when a qualifying market value EMI option is exercised, but again it is best practice to make an actual election not least in case there’s some unexpected problem with the EMI option that is discovered later. With EMI options that are granted with a strike price at less than market value it is essential that a s431 election is made when the shares are issued, as the deeming will not apply.
• If there is a share for share exchange, so the Sellers acquire shares in the Buyer, it is best practice to make elections for the Buyer shares even though strictly under the legislation it is not possible to make an election on a tax-neutral exchange of shares, as the s431 election history for the original shares (or lack of it) tracks through the exchange into the new shares.
• If there is a multi-level rollover and flip-up e.g. on a PE deal with loan notes in a Bidco, then Midco, then shares / loan notes in a Topco, for good order elections should be made at all levels i.e. including for the loan notes.
• If elections have been missed and this comes to light on a deal, often it is not a disaster. We frequently see Buyer tax due diligence reports where missed s431 elections have been identified, and very large potential PAYE and NIC liabilities are quoted. In many cases though, the history of the share acquisitions and the detail of the restrictions may present good arguments that the price originally paid for the shares was no less than UMV (meaning a lack of a s431 election would have no consequences) or that, at the time of acquisition, the shares had no restrictions attaching to them, or possibly only minor restrictions that could be argued to have had no impact on the value of the shares (which again would make the lack of election inconsequential). For example, it is the view of most advisers that model Articles of Association do not contain restrictions of the type that would impact the value of the shares.
• If an election has been missed on acquisition, it can be possible to open a further window for making an election by varying or removing a restriction attaching to the shares and then making a section 430 (not section 431) election to ignore the remaining restrictions, although this is quite rare to see in practice.
• It is the employer company (not the issuing company, if different) who must make the election. If there are multiple employers, multiple elections should be made as a belt and braces approach. Also the election is made with the employee by virtue of whose employment the shares are acquired – this will not always be the person who actually acquired the shares (e.g. where the spouse of an employee acquires restricted shares).
• Where consultants acquire shares, it is usually advisable to make a precautionary election just in case their employment status is ever challenged. Again this is just kept on file and not sent to HMRC.

If you have issues with section 431 elections (or, more likely, the lack thereof) for your clients, whether in the context of a problem being identified during a transaction or otherwise, don’t hesitate to contact us for assistance.