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What is a section 431 election?
A section 431 election is a tax form that an employee and their employer can sign when the employee gets shares (or similar investments) in connection with their employment, to reduce the risk of paying PAYE income tax and NICs on them later under the UK's ‘restricted securities' tax rules. It's most commonly signed when employees get shares as part of their pay or as a reward, including through share options.
Why do these tax rules exist?
The UK has a set of special tax rules called the “restricted securities” rules. These rules were created to stop employees from avoiding tax by getting shares with restrictions that lower their value, and then later removing those restrictions (or selling them for a price that doesn't take into account any restrictions) to get a tax-free benefit.
Without these rules, employees could pay less tax by getting shares that are worth less at first, and then making them more valuable later. The rules make sure that any increase in value from removing or ignoring restrictions is taxed as employment income (which is usually taxed at a higher rate than capital gains).
Even normal rules on employee shares – like having to give up shares if you leave the company – can count as restrictions and trigger these tax rules. This can lead to unexpected and higher tax bills for both employees and employers.
How does a section 431 election help?
A section 431 election lets the employee pay income tax on the full, unrestricted value of the shares when they first get them (to the extent they've paid a lower amount for them), instead of waiting until restrictions are lifted or the shares are sold. This means that there is usually no extra income tax or NICs to pay later (when the shares could be much more valuable), as any future increase in value is usually taxed at the lower capital gains rate.
For employers, this can also help avoid extra NICs costs if the shares go up in value later. Despite any income tax charge on the acquisition of the shares, often NICs are not payable at all at that point if there is no ready market for the shares – whereas NICs will normally be payable alongside any income tax that arises in the absence of a section 431 election when the shares are sold.
How and when do you make a section 431 election?
The election must be signed by both the employee and employer within 14 days of the employee acquiring the shares. The official HMRC template should be used, and in practice it is usually included with the share paperwork. You don't need to send the form to HMRC, but both sides must keep a copy in case HMRC asks for it.
Are there any downsides?
If the shares go down in value after the election, the employee will have paid tax on a higher value and can't get that tax back. If the shares can be taken away (for example, if the employee leaves before they “vest”), it might be better to wait and pay tax later, even if though the overall tax bill may be higher – any tax paid upfront can't be refunded if the shares are then lost. Employees should also think about whether they can afford to pay the tax up front. Getting a professional valuation can help everyone understand the costs and make a good decision.
International considerations
If the employee doesn't live or work in the UK, UK tax
might not apply, so the election may not be needed. However if
there's a chance the employee will move to the UK or start
working there before selling the shares, making the election as a
precaution can be wise – but the employee needs to have a
sufficient UK connection for the election to be effective.
Other countries, like the US, have similar rules (for example, the
“83(b) election”).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
