This article is the first in a series of articles which seeks to provide some basic guidance on the UK and US taxation of employee share awards. In future articles we will cover share options, other UK share plans and cross border issues associated with employee share awards.
Restricted shares (although it can be any property) are awarded in connection with your job in addition to cash and other benefits and payments. There are UK and US income tax consequences if you receive these awards.
What is restricted property?
It is property that is awarded to you (in this context, from (or behalf of) your employer or client) where your outright ownership is subject to some restriction. You own the property outright when the restrictions lapse. The restrictions could be performance targets or merely time based with a provison that you remain employed when the shares vest.
The asset is most often shares in your employer’s company, however it could be shares in other companies.
Taxation of restricted property
The following advice deals with UK and US taxation of UK residents involved with these arrangements. The tax situations of these type of arrangements that cross borders are more complex and will be dealt with in a separate article.
Restricted property awarded to an Employee
Income tax will generally arise at the point the restrictions lapse and the asset has fully vested (vesting). The fair market value of the asset at that point is subject to UK tax at your marginal rate of income tax. This will (usually) be a payroll event and the share vest should be shown on the relevant payslip.
It is possible to make an election to move the taxing point from the date it vests to the date of the initial award. The tax is then calculated on the value of the asset at that point. Any subsequent growth in value is subject to the (potentially) lower rates of capital gains tax. This election must be made within 14 days of the initial award of the restricted property. For UK tax purposes, this is referred to as a “Section 431 election”.
The taxable capital gain on the subsequent sale of the asset is calculated as the sale proceeds less the sum of 1) the amount paid for the asset, and 2) the amount subject to (UK) income tax.
Similar to the UK system, the property is taxed at the point the restrictions lapse and the asset has fully vested. The fair market value of the asset at that point is subject to UK tax at your marginal rate of tax.
The election to move the taxing point to the initial award date is also available for US income tax purposes. A separate election is required to be made within 30 days of the initial award and is referred to as an “83(b) election”.
The capital gain (for US purposes) is the excess of the net sale proceeds less the fair market value of the shares at vesting (or at grant if a S83(b) election has been made).
Restricted Property Awarded to a Consultant (sole trader/self-employed or company)
It is not uncommon for a consultant, providing services to a client directly, or through their own company, to receive restricted shares in the client (entity/company) as payment for their services.
The award will be subject to UK and US tax at the date the restrictions lapse and the fair market value (FMV) of the assets at that time will be subject to income tax as additional fees/income.
There is no option to make any election for taxation at grant for UK tax purposes (this only applies to employee related share awards. However, an election may be available for US tax purposes.
This is slightly more complex than self- employment because the individual is providing services to the client company as an employee of their own company. The client could either provide the restricted shares directly to the company, in which the value of the shares will be considered income of the company on vesting; this income will be subject to corporation tax at that time. A further charge will apply at the time the shares, or monies, are distributed to the owner/employee/director.
However, if the restricted shares are provided directly to the employee/director then they are related to that employment, albeit provided by a third party (the client) rather than directly by the employer. These are still fully subject to the usual rules covering restricted property for employees described above. There is the option to make the election for current taxation with the growth in value taxed as a capital gain (that is not available to the self-employed person).
For the US tax side of this situation, the US election described above is always available to the individual but if the restricted shares are issued to the company, the availability of the election will depend upon whether the owner has elected to disregard the company (made a “Check the Box” election – The beginners guide to US Taxation of Foreign Business Owners – PJD Tax).
Restricted shares can provide some interesting possibilities. The ability to take gains instead of earnings is a substantial benefit although it comes with risks (what if the shares lose value) and cash flow issues (pay the tax now and not later).
It is always best to consider both the UK and US tax issues associated with these types of awards in advance and we recommend always seeking advice when dealing or considering these matters.