ERSM30370 - Restricted Securities

Schedule 22, FA 2003: no charge on acquisition: forfeiture condition 5 years or less

Basic rule

A charge to income tax does not arise on acquisition of a forfeitable security where that forfeiture restriction will cease within 5 years of the date of acquisition – ITEPA03/S425 (2). This is the case whether or not other restrictions continue to apply after this five year period.

Exceptions to the rule

A charge to income tax may still arise if the securities are

• acquired under conversion rights (Chapter 3 Part 7 ITEPA 2003)
• acquired at less than market value, commonly “partly paid” shares (Chapter 3C Part 7 ITEPA 2003), or
• acquired pursuant to a securities option (Chapter 5 Part 7 ITEPA 2003).
• acquired on or after 2 December 2004 under arrangements, one of the main purposes of which is the avoidance of tax or NICs (ITEPA03/S431B) – see ERSM30380.
• Where the employee is either not resident or not ordinarily resident in the UK (see ERSM30300)

Electing out of basic rule

An election may be made under ITEPA03/S425 (3), between the employer and employee so that a charge arises on the actual market value on acquisition of the forfeitable security and the charges detailed above would not apply. Any election is to be made by agreement, must be in a form approved by the Board of Inland Revenue, must not be made more than 14 days after the acquisition of the securities and is irrevocable. Examples of election forms can be found by clicking on the links below:

Form for joint S425 election by employer and single employee

Form for joint S425 election by employer and many employees

By completing an election, income tax (and NICs if applicable) will be charged on the full market value of the security, ignoring the value of the forfeiture restriction, at the time the securities are acquired. No further charge to income tax (or NICs) will arise when the forfeiture restriction is lifted, regardless of any capital growth in the value of the security, which will fall under the capital gains tax regime. For capital gains tax purposes, taper relief runs from when the employee first acquires the forfeitable securities (see example at CG56506).

There is no refund of income tax (or NICs) if the market value of the securities is lower when the restrictions are lifted than when they were acquired. This also applies if after entering into the election the employee loses his job and the shares are sold at less than the amount paid for them or, indeed, are surrendered for nil. The approved election formats include a declaration to this effect.

Once signed the original and copies of the election(s) are kept by the employer and employee. They do not have to be submitted to HM Revenue & Customs unless requested as part of an enquiry.

The election under ITEPA03/S425 (3) is not appropriate when the desired treatment is the acquisition of a security at its full unrestricted market value, because ITEPA03/S425 (3) has the effect of taxing the restricted market value up front, rather than deferring the charge. Instead, an election under ITEPA03/S431 should be used (see ERSM30450). That election will automatically disapply the effect of ITEPA03 S425 (2).