Restricted Securities: Conditional shares acquired between 17 March 1998 and 15 April 2003: how are they taxed?
From 17 March 1998 where shares are acquired under a restricted share scheme subject to a condition that they can be forfeited at a later date then the provisions of Chapter 2 Part 7 ITEPA 2003 (as originally enacted) will apply. The tax treatment will depend partly on whether the period of potential forfeiture lasts for more than 5 years, or for 5 years or less.
Forfeiture period 5 years or less
Where the period is 5 years or less, there is no earnings charge as ‘money’s worth’ (ITEPA03/S62) when the restricted shares are first acquired.
When the risk of forfeiture is lifted, or the shares sold, there is a charge under ITEPA03/S427. This is based on the market value of the shares at that time, less any amount paid for them. But if the shares are actually forfeited there is no charge, unless the employee receives consideration for them.
The following examples are necessarily general - how the law applies in actual cases will depend on the specific facts of each.
Example 1: vesting period less than 5 years
On 1 May 2002 Tom Staples is given 2,000 shares subject to a risk of forfeiture. The risk of forfeiture is due to be lifted in May 2006, 4 years from the original acquisition of the shares. On 1 May 2006 the risk of forfeiture is lifted and the employee is free to keep the shares or to sell them. The market value of the shares on 1 May 2006 is £3,000.
There is no charge to tax in 2002/2003 by virtue of ITEPA03/S426.
For 2006/07 the amount chargeable under ITEPA03/S427 is the value at the time the risk of forfeiture is lifted, less the amount paid for the shares (in this case nil). So the taxable amount is £3,000.
Forfeiture period more than 5 years
If the period of the restriction is more than 5 years then there is no relief at the time the shares are acquired and there is a money’s worth charge under ITEPA03/S62 (2)(b) on the value of the shares at that time (taking account of the reduction in the value because of the restriction).
When the risk of forfeiture is lifted there is a further charge under ITEPA03/S427. This is computed in exactly the same way as for shares with a restriction period of less than 5 years, but the amount already charged to tax on acquisition is allowed as a further deduction in computing the amount charged to tax.
Example 2: vesting period more than 5 years
On 1 May 2002 Janice Rookes is given 1,000 shares subject to a risk of forfeiture. The risk of forfeiture is due to be lifted in May 2008, 6 years from the original acquisition of the shares. On 1 May 2008 the risk of forfeiture is lifted and the employee is free to keep the shares or to sell them. The market value of the shares on 1 May 2002 is £450 and on 1 May 2008 is £4,000.
There is a charge to tax in 2002/2003 on the money’s worth value of £450.
For 2009/09 the amount chargeable under ITEPA03/S427, as originally enacted, is the value at the time the risk of forfeiture is lifted (£4,000), less the amount paid for the shares (in this case nil), less any amount charged on acquisition (£450). So the taxable amount is £4,000 - £450 = £3,550.
The tax charge under ITEPA03/S427 is on:
- the value of the shares when the risk of forfeiture is lifted, less
- any amount paid for the shares, less
- any amounts brought into charge to income tax in respect of the receipt of the shares.
For these rules to apply:
- the shares must have been obtained by reason of the office or employment; and
- the shareholder must be an employee or director resident and ordinarily resident in UK at the time of acquisition of the shares (directors and employees include people who are going to be, or have been, directors or employees);
The charge on the lifting of the risk of forfeiture is ‘specific employment income’, per ITEPA03/S7 (4) and not subject to the ordinary rules of residence and domicile in Chapters 4 and 5 of Part 2 - see ERSM20100. It may still be chargeable even if the employee has subsequently left the UK.
No relief for forfeiture
If the shares are actually forfeit any earlier charge on acquisition is not revisited. Any loss is likely to be able to be claimed under the Capital Gains Tax regime.