Cassandra Graham, Tax Manager at Bates Weston explains the relevance of a section 431 election when an individual acquires employment related shares.

“The signing of a section 431 election tends to be a standard part of the legal process when an individual acquires shares but the relevance of the election is often misunderstood.

Firstly, the election is only relevant when the shares are acquired by reason of the individual’s employment and are considered as ‘employment related securities.’ Therefore as a general rule of thumb, unless the individual is an employee and or director and has acquired the shares as a result of their role, there is no need.

The most commonly known reason for signing a section 431 election is to ensure that the unrestricted market value of the shares is taxable on acquisition which ensures that there are no further income tax charges in the future, if restrictions are lifted. But again, this is only relevant if the shares are considered as ‘restricted securities.’ For the avoidance of doubt, most shares in privately owned businesses are considered as ‘restricted’ securities as the company’s articles often include a provision for directors to restrict the transfer of shares. Therefore when an employee acquires shares in a private company the section 431 election needs to be considered.    

It is less common knowledge that the section 431 election is important when determining the valuation method for the shares that are acquired and can have a significant impact on the tax consequences when shares are acquired by employees.

When an employee acquires shares (outside of a tax advantaged share scheme) the individual is subject to tax on the market value of the shares at the date they acquire them. Open market value in the context of acquiring shares can either be by reference to a ‘money or money’s worth’ basis or in accordance with capital gains tax valuations. There is a significant difference.

When valuing shares on an earnings basis, all information in relation to the company as well as personal characteristics and circumstances of the recipient needs to be considered, whether it is published or not e.g. a forthcoming sale or market for sale, separate side agreements,  shareholder agreements and company strategy changes etc. When valuing shares for capital gains tax purposes it is only necessary to take into account published information e.g. articles of association and published financial statements.

The significance of a section 431 election in this context is that the signing of one within 14 days of acquiring the shares ensures that the shares are valued in accordance with capital gains tax purposes. If it is likely that unpublished information and personal knowledge would significantly enhance the value of the shares an election would be invaluable and the tax savings could be huge.”

Take a look at our earlier blog on this subject and do get in touch today to speak with our tax specialists who regularly liaise with HMRC for share valuations and advise on employee share acquisitions.