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HMRC internal manual

Employment Related Securities Manual

HM Revenue & Customs
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Restricted securities: exchanges of restricted securities up to 16 July 2014

For exchanges of restricted securities on or after 17 July 2014, see ERSM30505.

Restricted securities may be exchanged in the circumstances of a take-over or a reorganisation of capital.

How they are dealt with depends on whether the ‘old’ securities were acquired before or on/after 16th April 2003, and in respect of the latter category whether an election has been made. The following analysis assumes that like value is received (i.e. AMV and UMV of old shares equals AMV and UMV of new shares). Where greater value is received than the old restricted shares were worth, consideration needs to be given to whether:

  • all restrictions have effectively been lifted, leading to an appropriate Chapter 2 charge (or original Chapter 4 for pre-16 April 2003 restricted shares),
  • a charge under Chapter 3D (securities disposed of for more than market value) arises, or
  • the extra value gives rise to an earnings charge within ITEPA03/S62.

Relief under section 429

Some situations where a complete class of share is exchanged and either:

  • the company is employee controlled through shares of that class, or
  • the majority of shares of that class are not employment-related securities

may result in exemption on disposal by virtue of ITEPA03/S429 (case outside charge under section 426).

Post-15/4/03 restricted securities exchanged for new restricted securities (no election)

The disposal of the old securities will create a chargeable event under ITEPA03/S427 (3)(c) and, to the extent that the value of OP has wasted due to the effluxion of time, there will be a charge to tax under section 428. This will then be reflected in a reduced charge on the restrictions being lifted from the new securities. This can best be illustrated with an example, ignoring any commercial increase in share value.

Example 1

Say a 5-year restriction on sale is imposed on shares with unrestricted value of £100, thus reducing their actual MV to £75, and Peter Meehan pays £75. Assume too a straight-line reduction in the effect of the restriction (so, £5 a year). After three years there is an exchange on a take-over of like-for-like restricted shares. Thus at year 3 there will be a Chapter 2 charge on:

UMV x (IUP - PCP - OP) - CE) = £100 x (0.25 - 0 - 0.1) - 0 = £15

followed at the end of year 5, when the restriction on the replacement share finally lifts, by a charge on:

UMV x (IUP - PCP - OP) - CE) = £100 x (0.1 - 0 - 0) - 0 = £10

Post-15/4/03 restricted securities exchanged for new restricted securities (with section 431(1) election on original securities)

Where an election has already been made for the old securities, then ITEPA03/S431 (1) states that sections 425 to 430 are not to apply to the old securities, so no charge can arise at the time of the exchange.

However, for the new securities, in the ITEPA03/S428 (3) formula for IUP, DA will be the actual market value of the old securities rather than their unrestricted market value, so that IUP will be greater than zero and there may be a charge on a later chargeable event in respect of the new securities:

IUP = (IUMV - DA)/IUMV = (£100 - £75)/£100 = 0.25

Any cases where the possibility of a charge arises in such circumstances should be referred to ESSU.

It should be noted that, where the exchange is not of like-for-like, the value of the new restricted securities could be much greater than what has been given up. In those circumstances there may well be a further charge, and a scenario for which another section 431 election should be considered.

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Pre-16/4/03 conditional shares exchanged for new restricted securities

The disposal of conditional shares (acquired pre-16/4/03) will create a charge under the original Chapter 2 provisions of ITEPA (previously section 140A ICTA 1988). The new restricted securities acquired will be dealt with in the normal way, so that on lifting of the restrictions there is likely to be a charge under the new Chapter 2 (restricted securities). Such a charge may be obviated by an election under ITEPA03/S431 (1), although that is likely to lead to an acquisition charge.

Example 2

Kevin Guerra is awarded 1,000 conditional shares in Alpha Ltd on 1 June 2002, forfeitable if he leaves his employment within 4 years. On 31 May 2005 there is a take-over and he exchanges his shares in Alpha Ltd for 1,000 shares in Beta Ltd, subject to potential forfeiture for the remaining year. Each share in Beta Ltd is worth £5 unrestricted, but the forfeiture condition reduces its value to £4.40. On 31 May 2006 each share is worth £6 when the condition of forfeiture is lifted.

In 2002/3 there is no charge on acquisition of conditional shares (see ERSM30230).

In 2005/6 Guerra has disposed of conditional shares for consideration of £4,400 (£4.40 x 1,000) so must pay tax on this computed under ITEPA03/S428 as originally enacted (see ERSM30230). He has now acquired restricted securities within the new legislation.

In 2006/7 Guerra will be liable under ITEPA03/S428 on the lifting of the restriction using the formula on the unrestricted value of shares, now £6 x 1,000 = £6,000:

UMV x (IUP - PCP - OP) - CE or £6,000 x (0.12 - 0 - 0) - 0 = £720 (see ERSM30400)

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Pre-16/4/03 restricted shares exchanged for new restricted securities

The roll-over provisions for company reorganisations as set out in ITEPA03/S462 (as originally enacted), which applies TCGA92/S127, continue to apply the old Chapter 4 charge to the replacement shares, per paragraph 9(4) Schedule 22 FA 2003. Section 127 TCGA 1992 deems the new holding to be the same asset as the original shareholding. So if a restriction is lifted the old rules under the original Chapter 4 charge on restricted securities apply.

Example 3

Sarah Parker is awarded 1,000 restricted shares in Gamma Ltd on 1 June 2002, with a 4 years restriction on sale. On 31 May 2005 there is a take-over and she exchanges her shares in Gamma Ltd for 1,000 shares in Delta Ltd, subject to a restriction on sale for the remaining year. Each share in Gamma Ltd was worth unrestricted £4 on acquisition, reduced by the restriction to £3. Each share in Delta Ltd is worth £5 unrestricted, but the no sale restriction reduces its value to £4.75. On 31 May 2006 each share is worth £6 when the sale restriction is lifted.

In 2002/3 there is a money’s worth charge on acquisition of restricted shares equal to their value of £3,000 (£3 x 1,000).

In 2005/6 Parker has disposed of restricted shares for consideration of other restricted shares. The new shares in Delta Ltd are treated as if they had been acquired on 1 June 2002. There is no chargeable event.

In 2006/7 the restriction lifts, but there uplift in value from immediately before lifting to immediately after lifting is negligible; so no charge - see ERSM30030.