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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Employment-related securities: acquired for nothing or at undervalue: employee: employment income: amount constituting earnings on acquisition

Income Tax liability may arise under the ordinary principles of employment income, S62 ITEPA03. When an asset in the form of a security is acquired by an employee through his employment and he acquires it free or pays less than its market value there will be a charge, because the employee who receives securities at less than their market value receives money’s worth. See ERSM20500. Any amounts charged to Income Tax by S62 ITEPA03 will, by the application of the market value rule in TCGA92/S17, have effectively been allowed already to the employee on the acquisition of the security. Any amounts on which liability arises under S62 ITEPA03 are not to be taken into account in computing the cost of the shares to the employee for Capital Gains Tax purposes.

There is an exception if the employment-related securities are restricted or convertible securities at the time of acquisition. (See CG56339 and ERSM30300+; CG56342 and ERSM40010+.)

Example

An employee buys 2500 £1 shares in the company for £2000 at a time when the market value of the shares is £2500. The shares are neither restricted nor convertible.

There is an amount constituting earnings under S62 ITEPA03 in respect of the difference between the market value of the shares, £2500, and the amount the employee pays, £2000.

The amount of £500 charged under S62 is not added to the employee’s cost of the shares for capital gains purposes. The capital gains cost is already £2500 as the market value rule, TCGA92/S17, applies to the acquisition.

In some circumstances an employee may acquire shares without having to pay their full value at the time and be charged to Income Tax not under S62 ITEPA03 but under S188 ITEPA03 on the benefit of a loan. In the example above suppose the employee had acquired the shares for £2500 paying £2000 and owing £500. There is no transfer at undervalue, as the employee still owes the employer £500. Nonetheless the employee holds the shares and is entitled to rights such as dividends arising from that ownership. Again the amount treated as earnings is not added to the employee’s cost of the shares for capital gains purposes. The capital gains cost is already £2500 as the market value rule, TCGA92/S17, applies to the acquisition.

Note the situation, however, where the employee is treated as having received a ‘notional loan’ and this is written off. The amount counting as employment income of the employee on the discharge is, under S446U(2) ITEPA03, added to the employee’s cost of the shares for capital gains purposes under S119A TCGA92, see CG56328. This will most commonly apply in cases where shares were received that were not fully paid up. In the example above suppose the employee had acquired 2500 £1 shares that were only partly-paid paying for them £2000, the market value of the partly-paid shares. Assume that had they been fully-paid their market value would have been £2500. The £500 difference is treated as a notional loan. As above, the employee holds the shares and is entitled to rights such as dividends arising from that ownership. If the liability to pay up the shares is released, the notional loan is treated as written off and £500 counts as income of the employee under S446U ITEPA03. In accordance with S119A TCGA92 this amount is added to the sum the employee gave for the shares making their capital gains cost £2500.