Ouch! Avoid picking the wrong valuation

Avoid picking the wrong valuation

An employee gets shares with two different valuations but if they pick the wrong one they pay 37% more tax.

When someone gets shares by reason of employment or status as an office holder, and this doesn’t happen via a tax-favoured share scheme, it usually creates an Income Tax liability (possibly National Insurance too). The employee picks up the tax liability on the difference between the acquisition price and the market value at the date of acquisition.

The rather complicated tax legislation that applies here means that a share actually has two values! One value incorporates all of the restrictions attaching to the shares such as the requirement to sell on cessation of employment or the Directors’ ability to block a transfer (the Actual Market Value) and a second value that ignores such restrictions (the Unrestricted Market Value). 

The Election

Unless the acquiring employee and employer jointly elect within 14 days of the date of acquisition to pay Income Tax on the Unrestricted Market Value (‘UMV’), the default position is that the Actual Market Value (‘AMV’) applies. This is a Section 431 Election.

Often the difference in Income Tax between the AMV and UMV at the date of acquisition is not great, but the absence of a Section 431 Election can result in unexpected Income Tax and National Insurance liabilities on a future disposal. This is because any proportion of the UMV that wasn’t paid nor subject to Income Tax on acquisition will be taxed as income on that disposal rather than being taxed as a capital gain. 

This can all get very expensive for the employee, especially if the shares are sold for a much greater price later on once the company has grown. For example, a 20% differential between AMV and UMV on acquisition means that 20% of the proceeds received on disposal will be subject to Income Tax and National Insurance then. 

The Result

Given that the desired outcome is surely to pay Capital Gains Tax charged at 10% if Entrepreneurs’ Relief is available and Income Tax and National Insurance rates can reach a combined 47%, an additional rate taxpayer could end up paying c37% more tax on the growth in value. Ouch!

So the benefit of making a Section 431 Election could be huge - and attention must be given to the merits of making this election at the point of acquisition - bearing in mind that there’s only a limited time window in which to make the election.   

Comment

Matthew Eady

Partner, Employment Tax
​I am a Partner in the Employment Taxes department. A lot of my time is spent advising companies on employee share incentive and reward arrangements; implementing share schemes and agreeing share valuations with HMRC. I also advise clients on employment tax matters generally, employment status queries and get quite involved in the P11D and Share Scheme Annual Return process.