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HMRC internal manual

Employment Income Manual

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HM Revenue & Customs
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PAYE: special type of income: shares ceasing to be only conditional or being disposed of

Section 698 ITEPA 2003

There are specific rules in Part 7 Chapter 2 ITEPA 2003 concerning conditional interests in shares. The rules determine when a tax charge arises and the amount that counts as employment income of an employee in respect of conditional shares (see Share Schemes Manual, SSM4.10).

These rules were amended by Schedule 22 FA 2003 with effect from 1 September 2003. However the new rules do not apply to shares acquired before 16 April 2003. The guidance below relates to conditional shares acquired before 16 April 2003. For restricted securities acquired on or after 16 April 2003 see EIM12200.

What are conditional shares?

Broadly, conditional shares are shares subject to a risk of forfeiture. Depending on the circumstances, an amount may be chargeable to tax as employment income under Section 427 ITEPA 2003:

  • when the risk of forfeiture is lifted
  • when the shares are sold.

Where there is an amount chargeable to tax as employment income by virtue of Section 427, the employer is required to operate PAYE if Section 698 ITEPA 2003 applies.

When does Section 698 apply?

Section 698 ITEPA 2003 applies if:

  • at a time when the employee has a beneficial interest in them, the shares cease to be shares in which the employee’s interest is only conditional, or
  • the employee sells or otherwise disposes of the employee’s interest or any other beneficial interest in the shares, or
  • the employee dies holding an interest in conditional shares

and, as a result, an amount is chargeable on any person under Section 427(1) ITEPA2003.

How does Section 698 apply?

If Section 698 ITEPA 2003 applies, the employee is treated as if he or she was provided by reason of the employment, and at the time conditions are lifted or shares sold, with shares in the nature of the original shares but without the relevant conditions. If those shares would be readily convertible assets, then the employer is required to operate PAYE.

The amount on which the employer is required to operate PAYE is the employer’s best estimate of the amount likely to be chargeable to tax as employment income under Part 7 Chapter 2 ITEPA 2003.