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HMRC internal manual

Employment Related Securities Manual

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HM Revenue & Customs
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Securities acquired for less than market value: example computations

Notional loan

Example 1: partly-paid shares

Eileen Baker is given 10,000 partly-paid ordinary shares. She pays nothing for them. The par or nominal value of the shares is £1, but they are paid up to 1p with an outstanding obligation to pay up 99p on each share if the company calls for it. Fully paid-up shares are worth £2 each, so partly-paid ones with call of 99p will be worth £1.01 each. Three years later she sells the shares for £20,100 (£2.01 each with the call still outstanding).

Year 1

Money’s worth charge on acquisition of shares 10,000 x £1.01 = £10,100

Notional loan created equal to call on shares 10,000 x 99p = £9,900

Annual charge for each year (subject to the threshold for the benefit of the loan to be treated as earnings per ITEPA03/S180, see EIM26140) £9,900 @ say 5% = £495 p.a.

Year 3

Until 16 July 2014, even though the call remained outstanding at the time of the sale the notional loan of £9,900 was treated as discharged under ITEPA03/S446U(1)(a), giving rise to employment income in that amount under ITEPA03/S446U(2). From 17 July 2014, the notional loan is treated discharged without giving rise to a charge under Chapter 3C. See ERSM70140 

Example 2: payment for forfeitable shares by instalments

Caroline Cross is awarded £10,000 worth of shares. They will be forfeited if she leaves employment within the following 3 years. Only £1,000 is payable on acquisition, with the remaining £9,000 payable in 5 yearly instalments of £1,800. After 3 years the shares are worth £12,000.

Year 1

When the shares are acquired the market value is £10,000. £1,000 is paid on acquisition, with the remaining £9,000 to be paid later. There is therefore no money’s worth charge under ITEPA03/S62, but there is a charge under Chapter 3C Part 7 ITEPA 03. For Chapter 3C purposes, the only deductible amount is the £1,000 paid by the employee, so that the notional loan charge would be calculated on an initial amount of £9,000. However the shares are forfeitable, so there is no charge to Income Tax under ITEPA03/S425. Consequently there is no charge under Chapter 3C until the forfeiture condition lifts by virtue of ITEPA03/S446Q (4).

Year 3

When the forfeiture condition lifts there will be a chargeable event under ITEPA03/S427 (see ERSM70100). The original actual market value is paid or payable in full so the amount of charge computed under ITEPA03/S428 is nil.

However, not all of the market value at acquisition has been paid and there is deemed to be a notional loan from the time when the first chargeable event occurs. The employment-related securities are deemed to be acquired at that date. Under ITEPA03/S446T(1) the amount of the notional loan is computed using the market value at the time of the (deemed) acquisition. So the ‘initial’ amount of the notional loan will be:

Market value at deemed acquisition 12,000  
     
less paid at acquisition (1,000)  
paid year 1 (1,800)  
paid year 2 (1,800)  
paid year 3 (1,800)  
paid under S426 (nil) Notional loan = £5,600

In Years 4 & 5 the amount charged as a notional loan will reduce each year as the remaining instalments of £1,800 are paid, leaving £2,000 outstanding. There may be a continuing annual charge on this if the aggregated loans and notional loans limit is exceeded (see ERSM70130) and there will be a final charge on £2,000 if the shares are sold (see ERSM70140).

If the shares had fallen in value by Year 3 then the notional loan would be extinguished earlier and there would be no charge on sale of the shares. An election under ITEPA03/S431(1) at the time of original acquisition (see ERSM30450) would not prevent any Chapter 3C charge, but would bring forward the charging point to the original acquisition and prevent any increased Chapter 3C charge should the shares rise in value.

This treatment on the sale of the shares does not alter with the changes to ITEPA03/S446U that were introduced by Finance Act 2014, with effect from 17 July 2014, unless the market value of the securities does not change between the date of their actual acquisition and the date that is treated by virtue of ITEPA03/S446Q(4) as the date of acquisition for the purposes of Chapter 3C. Only in that circumstance will the actual or contingent liability to make one or more further payments be equal to the amount initially outstanding, so that ITEPA03/S446U(1A) provides that the sale does not give rise to a charge. See ERSM70140 

Example 3: employer’s loan to buy shares with section 431 election

Mr Smith has been offered the opportunity to subscribe for 100,000 restricted (forfeitable) shares in the Company he works for, at an aggregate subscription price of £100,000. The aggregate unrestricted market value of the shares is £150,000 and Mr Smith has decided to enter into a section 431(1) election in order to pay income tax and NICs, up-front, on the difference between the subscription price and the (higher) unrestricted market value of the shares. The Company has agreed that, whilst Mr Smith will be issued with his shares, he does not have to pay the subscription price until the earlier of (a) an exit event (such as a sale or listing) or (b) the cessation of his employment. An election under ITEPA03/S431(1) has effect for relevant tax purposes per subsection (3) including:

  • determining any amount that is to constitute earnings from the employment under Chapter 1 of Part 3 (earnings),
  • operating Chapter 3C of Part 7 (acquisition of securities for less than market value),

The effect of the election is to bring forward the Chapter 3C charge to the time of acquisition. So there is an ITEPA03/S62 charge on acquisition of the shares on £50,000 (£150,000 less the deferred subscription price of £100,000) and a notional loan of £100,000 created on which there will be an annual charge at the appropriate rate. The amount of the notional loan is determined in accordance with ITEPA03/S446S, being the unrestricted market value of £150,000 less a deductible amount equal to the ITEPA03/S62 charge on £50,000 under ITEPA03/S446S(3)(b). If the subscription price is paid up before sale, this is treated as a discharge or “repayment” of the notional loan under ITEPA03/S446U(4)(a). The annual charge will cease and there will be no further charge. However, for periods up to 16 July 2014, if the shares are sold before the payment of the subscription price is made, there would be a charge on £100,000 under ITEPA03/S446U(2). In those circumstances HMRC accepted that where sale and “repayment” of the notional loan were part of one transaction, the “repayment” was treated as being made first.

From 17 July 2014, in this example the sale of the shares does not result in the discharge of the £100,000 notional loan. Rather, the notional loan is treated as discharged under ITEPA03/S446U(4)(a) when the subscription price is paid up, regardless of whether that occurs before, at the time of, or after the sale. See ERSM70140