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Pop art s431 tax election
Option Schemes Published:  Jun 27, 2023 8 min read
Expert reviewed

S431 and NIC tax elections: what are these forms for share option holders?

Suzanne Worthington
Writer
Suzanne Worthington

Senior Writer

Alda Daci
Expert contributor
Alda Daci

Share Options Expert

Expert contributor
Valeria Ivasikh

Legal Manager

When you sign an s431 election with an employee who is exercising their share options, you both confirm that the employee will only pay Income Tax once: when they exercise their options.

When you sign an NIC election with an employee who is exercising their share options, you both agree to transfer to the employee the employer’s liability to pay National Insurance Contributions due on exercise.

In this post, we explain why you might encounter and be asked to sign s431 and NIC tax elections if you run a company share option scheme, or if you’re an employee granted share options.

Tax elections are important and often misunderstood. In this post, we explain what they’re for, when to use them, and why sign them.

Need an s431 or NIC election form template?
You can create and sign s431 and NIC elections on SeedLegals. Our EMI and Unapproved option schemes are compatible with these popular tax elections.
This is not tax advice. Your tax liability depends on your situation so for personalised advice, you need to consult a qualified, independent accountant or tax advisor.

Tax elections for option schemes

There are two tax elections relevant for EMI and Unapproved option schemes:

  • ITEPA Section 431 election (s431 election)
  • National Insurance Contributions election (NIC election)

These are joint elections, meaning that the choice (the ‘election’) needs to be made by both the option holder and the company, and this is done by signing the relevant document.

An employee and the company typically sign these elections when an employee exercises options – but the elections cover more situations than just the exercise. In particular, they cover the tax liability the employee has when they eventually sell their shares.

Keep reading to find out what exactly is agreed in s431 and NIC elections…

 

What is an s431 election?

The ‘section 431’ election is a legal document signed by an employer and employee to confirm that the employee agrees to pay Income Tax when they exercise their options, so that when they sell their shares in future, they only have Capital Gains Tax to pay.

The s431 election makes sure Income Tax is only paid once when someone acquires shares. For startups, a typical situation to sign an s431 election is when the employee exercises their share options. Here’s what happens:

  1. Employee and employer sign s431 election to agree the option holder will pay Income Tax straightaway when they exercise options, and that the Income Tax will be paid on the difference between the Unrestricted Market Value (UMV) of the option shares and the Actual Market Value (AMV) (see box below).
    The Income Tax due could be zero, but it’s still worth signing the s431 to avoid the employee having to pay Income Tax on the shares in future.
  2. Employee exercises options
  3. Employee pays Income Tax due on exercise, on the difference between AMV and UMV. (Again, the Income Tax due could be zero.)
  4. When the employee later sells their shares, they will usually owe Capital Gains Tax, but because they signed the s431, they won’t be liable for Income Tax on the gain they’ve made on the shares.
Actual Market Value (AMV) = how much the shares are worth with any restrictions (for example, the shares can only be sold if the company is sold)
For EMI options, the AMV is typically the exercise price (strike price) the option holder must pay when they exercise their options.

Unrestricted Market Value (UMV) = how much the shares would be worth without any restrictions – the UMV is usually higher than the AMV.

Read more in our guide: Everything you need to know about AMV and UMV

What is an NIC election?

An NIC election is a legal document where you agree to transfer the liability for paying the employer’s share of National Insurance Contributions (NIC) to the option holder.

That doesn’t sound great for the employee but for UK startups, it’s typical for companies to move this tax burden onto employees to reduce the costs to the company of running a share option scheme.

National Insurance isn’t usually due when holders exercise their share options if the exercise price is set at the AMV. But if National Insurance is due, then here’s how it works:

  1. HMRC approve the NIC election
  2. Employer and employee sign the HMRC–approved NIC election
  3. Employee exercises options
  4. Employee is responsible for paying any secondary National Insurance Contributions due. Usually the employer pays the NICs and the employee reimburses them. With the NIC election in place, the amount the employee pays in National Insurance can be taken off the amount of Income Tax the employee owes at exercise. (This is explained on the gov.uk website.)

 

Why do startups ask employees to sign s431 and NIC elections?

In the UK, when you grant someone share options, they don’t normally incur any tax liability at the time you grant the options.

It’s only when a holder exercises their options (converts their options into shares), which could be years later, that a tax liability might arise.

Alda Daci

EMI option schemes come with tax advantages
For example, option holders don’t usually have to pay Income Tax when they exercise their EMI options because they pay a strike price pre-agreed with HMRC.

But Income Tax could still be payable when EMI options become shares
For example, if the employee pays less than the strike price agreed with HMRC, or if they exercise their options more than 90 days after they leave the company.

Alda Daci

Share Options Expert,

SeedLegals

    For EMI option holders

    If an employee exercising their options pays a strike price that’s the Actual Market Value (AMV) the company agreed with HMRC when the options were granted (the AMV is confirmed in the EMI Valuation) and the employee does not sign an s431 election, then they don’t pay Income Tax at this point, but Income Tax will be due on the shares from these options in the future.

    However, if they do sign an s431 election, then Income Tax will be due on exercise, and it’s charged on the difference between the UMV and the AMV. The s431 election has the effect of bringing forward the Income Tax liability for the shares, so the employee pays it now, at exercise, and not in the future.

    When the employee later sells their shares, they’ll pay Capital Gains Tax (because the shares are from EMI options, if they’ve held the shares for at least two years it will be at the 10% rate), but not Income Tax.

    For Unapproved options holders

    Unapproved options holders who are employees or directors of the company can also sign an s431 election and pay Income Tax when they exercise share options. They can also sign an NIC election. See above for why signing these elections could be a good idea.

     

    Worked example: s431 election and Unapproved share options

    Let’s say company Xample grants employee Xavier Unapproved share options.

    A few years later, Xavier exercises 1,000 options and he becomes a shareholder. There’s a restriction on his shares which means he can only sell them when Xample’s majority shareholders sell the company.

    When Xavier is given his shares:
    – the strike price is £1
    – the market value is £2

    Without s431 election 📄❌

    On exercise, Xavier pays £1 per share, so he pays £1,000 in total.
    Because the market value is £2, HMRC consider this 50% discount to be a gain, so Xavier will need to pay Income Tax on the discount:

    Total discount is (£2 – £1) x number of shares = £1,000

    Let’s say Xavier is a Higher rate taxpayer so he’s charged 40% Income Tax:

    Income Tax to pay = 0.4 x 1,000 = £400

    Several years later, Xavier sells his shares for £5 each as part of the sale of the company.

    Total Xavier receives for the shares is £5 x 1,000 = £5,000
    Xavier’s gain is £5,000 – £1,000 = £4,000

    Xavier’s discount on the market value was 50% and it’s this percentage of his gain that’s subject to Income Tax.
    Xavier owes Capital Gains Tax on the rest of the gain (50%). And because the shares were from Unapproved options, the CGT is the full rate of 20%

    Income Tax due is 0.4 x (0.5 x 4,000) = £800
    Capital Gains Tax due is 0.2 x (0.5 x 4,000) = £400
    Total tax due on the sale of the shares = £1,200

    Total tax paid on these shares is (tax at exercise) + (tax on sale):
    400 + 1,200 = £1,600

    Xavier made a gain of £4,000
    And paid £1,600 in total in Income Tax and Capital Gains Tax
    So his net profit is £2,400

    Note: this doesn’t include any other taxes which might be due, such as National Insurance Contributions.

    With s431 election 📄✅

    Xavier has signed the s431 so when he sells the shares in future, he won’t have to pay Income Tax on the gain. Xavier will still be liable to pay Capital Gains Tax but instead of paying any Income Tax, he’ll pay only CGT (the shares are from Unapproved options so CGT is at the full rate of 20%) on the entire gain. This could be a significant saving.

    Here’s how it works out with the s431 election for Xavier:

    On exercise, Xavier pays £1 per share, so he pays £1,000 in total.
    The market price is documented as £2.
    Because Xavier and the company signed the s431 election, Xavier will need to pay Income Tax on the discount:

    Total discount is (£2 – £1) x number of shares = £1,000

    Xavier is a Higher rate taxpayer so he’s charged 40% Income Tax:

    Income Tax to pay = 0.4 x 1,000 = £400

    Several years later, Xavier sells his shares for £5 each as part of the sale of the company.

    Total Xavier receives for the shares is £5 x 1,000 = £5,000
    Xavier’s gain is £5,000 – £1,000 = £4,000

    Because Xavier and the company signed an s431 tax election, there’s no further Income Tax to pay.
    Xavier owes Capital Gains Tax on the gain at the rate of 20% (the shares are from Unapproved options so CGT is at the full rate of 20%).

    Income Tax due is zero
    Capital Gains Tax due is 0.2 x (4,000) = £800

    Total tax paid on these shares is (tax at exercise) + (tax on sale):
    400 + 800 = £1,200

    Xavier made a gain of £4,000
    And paid £1,200 in total in Income Tax and Capital Gains Tax
    So his net profit is £2,800

    Note: this doesn’t include any other taxes which might be due, such as National Insurance Contributions.

    By signing the s431 election, Xavier is £400 better off.

     

    Who can sign an s431 and/or NIC election?

    S431 and NIC elections are only available for PAYE employees who pay UK Income Tax and NIC. This is usually the case for employees who live in the UK but it can include non-resident employees if HMRC consider them to ‘perform duties in the UK’.

    If you’re not sure, it’s best to check with your accountant or tax adviser.

     

    When to sign s431 and NIC elections

    On SeedLegals, you can create and sign an s431 election when an option holder exercises their options.

    You can create and sign a NIC election when you grant options to staff. To be effective, NIC elections have to be approved by HMRC, which can take up to a month.

    Both elections can be signed anytime but to apply to the tax treatment when exercising share options, they must be signed before exercise or up to 14 days after exercise. After that, the elections won’t be valid for the exercise.

     

    More resources

    There’s more detail about tax elections in our posts:

    Talk to the experts

    If you have any questions about EMI and Unapproved option schemes, hit the chat button (bottom right of this screen) to send us a message.

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    Suzanne Worthington

    Suzanne Worthington

    Sooze is our Senior Writer. She's obsessed with making complicated things easy to understand.
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