UK: Restricted Securities Regime Elections

Last Updated: 21 January 2010
Article by Conor Brindley

With private equity transactions appearing to be on the increase, perhaps now is a good time to revisit what employers and employees need to consider when deciding whether or not to make a restricted securities regime election.

The underlying principle of the restricted securities regime is that if an employee acquires restricted securities (e.g. shares which are subject to transfer restrictions), income tax on the proportion of the unrestricted market value ("UMV") (i.e. the market value of the restricted securities ignoring the effects of the restrictions) which represents the difference between the actual market value of the securities, taking account of the restrictions ("AMV") and the UMV of the securities, is deferred. When a restriction is lifted or the securities are sold (a chargeable event), the proportion of the unrestricted market value which is released is then charged to income tax.

Without such a regime, when restrictions are lifted (and as such increasing the value of the employee's holding), the rise in value would not be taxed and any gain arising when the restricted securities are sold would only be taxed under the capital gains tax regime (which tends to be much more favourable to a tax payer than the income tax regime).

Restricted Securities

The restricted securities regime is contained in Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA"). It applies to "securities" or "interests in securities" which are both "employment related securities" and "restricted securities" or "restricted interests in securities".

The above terms are defined in the legislation. Although the scope of this article does not extend to considering their meaning in detail, as Chapter 7 has been drafted with a pronounced anti-avoidance motive, it will be of no surprise that each term is given a wide meaning. In the context of private equity transactions, shares acquired by a manager, for example in a company incorporated to acquire a target, will be restricted securities if the shares are subject to "good/bad leaver" provisions and such provisions reduce the market value of the shares.

As mentioned above, the restricted securities regime is broadly designed to impose an income tax charge on any untaxed value of restricted securities owned by an employee when the restrictions on the securities are lifted or the restricted securities are sold.

It should be noted that where an income tax charge arises on the lifting of a restriction, the employee will have to find the money to pay the tax bill. The same is true if an income tax charge arises on making a restricted securities regime election at the time of acquisition (see below).

On the occurrence of a chargeable event, the taxable amount is calculated in accordance with the following formula:

(UMV x (IUP – PCP – OP)) - CE


UMV is the unrestricted market value of the securities immediately after the chargeable event (i.e. their market value ignoring the effects of the restrictions).

IUP is the "initial uncharged proportion" and its value is calculated by using the formula:


In this formula:

IUMV is the unrestricted market value of the securities at the time they were acquired.

DA is the total of the deductible amounts (basically the consideration paid to acquire the restricted securities, plus any amounts already treated as taxable income arising from the restricted securities).

PCP is the "previously charged proportion" and is the proportion which has already be charged to tax on previous taxable events under the restricted securities regime. If there have been no previous taxable events, PCP will be zero.

OP is the "outstanding proportion" and is the proportion that is not chargeable under the current taxable event, but may be charged on a future taxable event under the restricted securities regime. OP is calculated using the formula:


In this formula:

UMV is the unrestricted market value of the restricted securities immediately after the relevant chargeable event.

AMV is the actual market value of the restricted securities (taking all restrictions into account) immediately after the relevant chargeable event.

CE is any available costs and expenses (e.g. consideration given by the employee in connection with the lifting of restrictions).

An Excel spreadsheet to assist employees and employers to calculate the taxable amount under the restricted securities regime is available on request from HMRC.

Straightforward Example

An employee is invited to acquire a number of shares for 80p per share in his employer company, each with an initial unrestricted market value (IUMV) of £1, on terms that he is restricted from transferring the shares for four years (it is this restriction which has reduced the market value of each share from £1 to 80p). At the end of the four year period, the shares have an unrestricted market value (UMV) of £5 each.

After four years a charge to income tax will arise on:

UMV x (IUP – OP)


UMV = £5

i.e. £5 x 0.2 = £1

As can be seen in a straightforward case, the taxable proportion of the unrestricted market value will equal the discount enjoyed by the employee when the restricted securities were acquired, expressed as a proportion of the unrestricted market value. In other words, as the amount paid by the employee for the shares (80p) represents a discount of 20%, when the restrictions expire in four years time and the shares are worth £5, income tax is chargeable on £1 (20% of £5).

It should be noted that if, for example, the employee had paid 50p per share (30p less than each share's actual market value) a liability to income tax equal to 30p per share would arise in respect of their acquisition under the general earnings charging provisions.

It should also be noted that if the employee had paid £1 per share (i.e. had paid the unrestricted market value for each share), no restricted securities tax charge would arise in the future. However the practical difficulty here in the context of shares in a private company is valuing the shares as such a valuation is more of an art than a science. It is, therefore, unlikely that HMRC's and an employee's unrestricted market value of shares in a private company would be the same.

To alleviate this practical difficulty HMRC and the British Venture Capital Association on 25 July 2003 jointly issued a memorandum of understanding which, amongst other things, describes the circumstances in which HMRC will normally (and in the absence of any tax avoidance) accept that managers acquiring restricted securities in a venture capital or private equity backed company do so for a price which is not less than their initial unrestricted market value (so that no charge to income tax will arise on acquisition nor subsequently upon the occurrence of a chargeable event).

The full text of the memorandum can be found by visiting the British Venture Capital Association's website (

Unappealing Feature

One of the most unappealing features of the restricted securities regime is that tax can still be due if the value of the restricted securities declines between the date of acquisition and the chargeable event. This is the case even if the unrestricted market value at the time of the chargeable event is less than the amount the employee actually paid for the restricted securities.

In the above example, if the unrestricted market value of each share at the time of the chargeable event had fallen to 60p, the taxable amount per share would be:

60p x (0.2 – 0) = 12p

i.e. 20% of 60p.

Section 431(1) ITEPA Election

The employer and employee may elect for the securities to be taxed on acquisition as if all restrictions were disregarded. Such an election is often referred to as a "section 431(1) election" and is irrevocable. If such an election is made, the employee will be charged income tax (under the general earnings charging provisions) at the time of the acquisition by reference to the full initial unrestricted market value (IUMV) of the shares. This will normally increase the amount of tax payable at the time of acquisition, but the effect is to disapply the restricted securities regime altogether so that, going forward, all growth in value should be charged to tax under the capital gains tax regime.

It should be noted that the making of a section 431(1) election does not protect against future charges to income tax under the other chapters of Part 7 of ITEPA which deal, amongst other things, with convertible securities, securities with an artificially depressed market value, securities disposed of for more than the market value and post-acquisition benefits from securities. It should also be noted that other elections under the restricted securities regime can be made although a consideration of them is outside the scope of this article.

Section 431(1) Election Example

Taking the facts in the above example, the effect of a section 431(1) election would be an immediate charge to income tax on the employee of 20p (£1 (IUMV) – 80p (amount paid by employee)) per share. Typically, such a charge would be under the general earnings charging provisions and no further charge to income to tax would then arise under the restricted securities regime.


If the restricted securities that are acquired are "readily convertible assets", any income tax payable either on acquisition or on the occurrence of a chargeable event, must be accounted for by the employee's employer under PAYE. Any tax due under PAYE should be recovered from the employee within 90 days. If it is not, a further charge to income tax may arise.

Likewise, if the restricted securities acquired are readily convertible assets, a liability to both employer and employee Class 1 NICs will normally arise on the same amount as that on which PAYE is to be accounted for.

Factors To Consider When Deciding Whether Or Not To Make A Section 431(1) Election

Typically an employee would want to make a section 431(1) election if he considers that the up-front tax charge is affordable. Obviously, if the restricted securities have a low unrestricted market value at the time of acquisition (but have the potential for significant growth in value), this may make an election more appealing. However, an employee also needs to be aware that he may not keep the restricted securities (even though he paid tax on acquiring them), the restricted securities may not increase in value as expected and he may pay more tax because of the election than he would have done without it. The employee will need to balance these risks against the potential advantages of avoiding a restricted securities regime charge on a much increased value at a later date and only having to pay capital gains tax on a disposal of the restricted securities.

Most employees make a section 431(1) election on a precautionary basis. This will be the case where the employee considers that he has paid at least the unrestricted market value of the restricted securities and as such it is expected that no restricted securities regime charge could arise. But, as confirmation of the unrestricted market value cannot be agreed with HMRC on acquisition, it is not possible for the employee to be absolutely sure that no restricted securities charge can arise (unless the conditions in HMRC/BVCA memorandum are satisfied). HMRC have confirmed that such a precautionary election will not make HMRC think that the employee and the employer believe that the employee paid less than the unrestricted market value.

In respect of an employer, although making a section 431(1) election may crystallise an immediate employer Class 1 NIC liability, the advantage of making the election is the avoidance of any future liability to account for any employer Class 1 NICs on an amount on which income tax might otherwise be charged on the occurrence of a chargeable event under the restricted securities regime. For this reason, it is not uncommon, in private equity transactions, for directors and employees offered an opportunity to acquire shares in a company with institutional investors to be obliged to make a section 431(1) election as a condition of acquiring shares.

Form And Timing Of Section 431(1) Election

The election must be made in the form specified by HMRC and must be made not later than 14 days after the acquisition. The election does not need to be filed with HMRC, although it must be retained by the employer as HMRC may want to see it to confirm the tax treatment of securities. The employer must, however, on its annual Form 42 return, indicate that an election has been made.

This publication is intended merely to highlight issues and not to be comprehensive nor to provide legal advice. Conor Brindley is an associate with Rosenblatt Solicitors and can be contacted at

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions