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HMRC internal manual

Employment Related Securities Manual

Restricted securities: no charge on acquisition: forfeiture condition 5 years or less

Basic rule

A charge to income tax on earnings does not arise on acquisition of a forfeitable security where that forfeiture restriction will cease within 5 years after the date of acquisition - ITEPA03/S425 (2). This is the case whether or not other restrictions continue to apply after this five year period.

5 years

HMRC regards the 5-year period as commencing at midnight at the end of the day of acquisition and expiring at midnight on the fifth anniversary of the day of acquisition.

So, if acquisition were on 1 June 2004, the 5-year period would run from midnight on 1 June 2004 to midnight on 1 June 2009.

Exceptions to the rule

A charge to income tax may still arise if the securities are

  • acquired under conversion rights (Chapter 3 Part 7 ITEPA 2003)
  • acquired at less than market value, commonly ‘partly paid’ shares (Chapter 3C Part 7 ITEPA 2003, but see ERSM70100), or
  • acquired pursuant to a securities option (Chapter 5 Part 7 ITEPA 2003).
  • acquired on or after 2 December 2004 under arrangements, one of the main purposes of which is the avoidance of tax or NICs (ITEPA03/S431B) - see ERSM30380.
  • Where the employee is not resident in the UK (see ERSM30300)

Electing out of basic rule

An election may be made under ITEPA03/S425 (3), between the employer and employee so that a money’s worth, general earnings charge arises on the actual market value on acquisition of the forfeitable security. Any election is to be made by agreement, must be in a form approved by the HMRC Commissioners, must not be made more than 14 days after the acquisition of the securities and is irrevocable. Examples of election forms can be found by clicking on the links below:

Form for joint S425 election by employer and single employee (Word 28KB)
Form for joint S425 election by employer and many employees (Word 35KB)

The election removes the exemption from income tax liability (and NICs if applicable) on acquisition that is provided by ITEPA03/S425(2).Consequently, the money’s worth of the security, taking into account reductions in respect of the forfeiture, and any other restriction, will be charged as general earnings at the time the securities are acquired.

When the forfeiture or any other restriction is lifted, this will constitute a chargeable event in accordance with the normal working of Chapter 2. The amount charged to income tax as earnings on acquisition, as a result of the election, will be a deductible amount under ITEPA03/S428(7)(b).

There is no refund of income tax (or NICs) if the market value of the securities is lower when the restrictions are lifted than when they were acquired. This also applies if after entering into the election the employee loses his job and the shares are sold at less than the amount paid for them or, indeed, are surrendered for nil. The approved election formats include a declaration to this effect.

Once signed the original and copies of the election(s) are kept by the employer and employee. They do not have to be submitted to HM Revenue & Customs unless requested as part of an enquiry.

The election under ITEPA03/S425 (3) is not appropriate when the desired treatment is the taxation at the time of acquisition of a security at its full unrestricted market value, because ITEPA03/S425 (3) has the effect of taxing only the restricted market value up front. Instead, an election under ITEPA03/S431 should be used. That election will ensure that ITEPA03/S425 to ITEPA03/S430 do not apply, (see ERSM30450).

From 6 April 2015, with the removal of the residence exclusion at ITEPA03/S421E (see ERSM20300), Chapter 2 can apply to restricted securities acquired whilst the employee is not resident in the UK and not carrying out duties in relation to a UK employment. However, an election under ITEPA03/S425 (3) may not be made unless at the time of the acquisition of the restricted securities, the earnings from the employment to which the election relates are UK general earnings to which any of the charging provisions of Chapters 4 and 5 of Part 2 apply.