Section 431 Election: The Complete UK Guide

What is a Section 431 election?

A Section 431 election is a joint, written election made by an employer and an employee (or director) under section 431 of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA"). It is used whenever an employee acquires restricted securities - typically shares carrying leaver clauses, transfer restrictions, forfeiture provisions or compulsory transfer triggers.

The election tells HMRC that, for income-tax purposes only, the shares should be treated as if none of those restrictions existed at acquisition. The practical effect is twofold:

• The employee is taxed at acquisition on the Unrestricted Market Value (UMV) rather than the lower Actual Market Value (AMV).
• Any future growth in value is taken outside the restricted-securities regime and treated as a capital gain on eventual sale.

Without the election, the original AMV/UMV gap *and* most of the subsequent growth can be re-characterised as employment income on later "chargeable events" - subject to income tax and (often) employer's and employee's National Insurance contributions ("NICs"). The election crystallises a small income-tax charge now in exchange for capital-gains treatment later.

Why Section 431 exists

Part 7, Chapter 2 of ITEPA was designed to stop employees converting employment income into capital gains by structuring share awards with artificial restrictions that depressed the acquisition value. Under the default rules:

• The employee is taxed at acquisition only on the restricted value (AMV).
• When a restriction later lifts, varies or is waived - or when the shares are sold - the proportion of value originally suppressed by the restriction comes back into charge as employment income.

That default protects the Exchequer but penalises commercially normal arrangements - sweat equity, founder packages, growth shares, unapproved options - where the restrictions are genuine but value growth is expected to be significant. Section 431 is the safety valve: the employee agrees to pay income tax up-front on the full UMV, and in exchange the shares behave like any ordinary capital asset thereafter.

The 14-day window

The election must be made within 14 days of acquisition. The deadline is statutory and HMRC has no discretion to extend it. Late elections are simply invalid - the shares remain restricted securities for tax purposes and the employee loses the capital-gains treatment permanently for that acquisition.

"Acquisition" usually means the date the employee becomes the beneficial owner of the shares:

• For direct share issues or transfers - the date of allotment or stock-transfer registration.
• For option exercises that produce restricted shares - the date the option is exercised, not the date it was granted.
• For nil-paid or partly-paid issues - the date the shares are allotted, not the date payment is completed.

In practice the 14 days runs from the share-register entry. Companies that issue shares first and "deal with the paperwork later" routinely miss the window. The election cannot be back-dated and HMRC will not accept one signed on day 15.

What the election covers

A Section 431 election can be made in one of two forms:

• Full election - disapplies *all* restrictions, so the shares are valued at full UMV. This is the standard election and the one used in the vast majority of cases.
• Partial election - disapplies one or more specific restrictions named in the election. The shares are valued ignoring only those restrictions; others continue to bite. Partial elections are rare in practice because they add complexity without much tax saving.

Both versions must be signed by the employer and the employee, name the shares acquired, and identify the election as being made under section 431(1) (full) or 431(2) (partial). HMRC publishes specimen wording that is universally used.

The election is not filed with HMRC at the time it is signed. Both parties retain a copy and it is produced if requested - typically during a PAYE compliance review or when HMRC's Shares and Assets Valuation team queries the annual ERS return.

Section 431 vs Section 425 vs Section 430

The restricted-securities regime contains three related election routes. They sit alongside the default ITEPA Chapter 2 charge and are easy to confuse:

Section 431 is by far the most common because it gives the cleanest tax outcome for both parties and is widely understood by HMRC.

Why almost everyone elects

Three reasons make the Section 431 election the default recommendation for any non-EMI share award.

Certainty. Without the election, the employee carries a contingent income-tax charge that crystallises only when a restriction lifts or the shares are sold - potentially years later, on a value the employee no longer controls. The election converts that contingent charge into a known, immediate one.

Employer NICs exposure. On a chargeable event under Chapter 2, both employee and employer NICs are due on the income-tax slice. For a share that has grown from £1 to £10 with no election, the employer can find itself paying 15% NICs on a £9 gain it never received. The election removes that exposure entirely.

Capital-gains rate arbitrage. The combined income-tax-plus-NICs rate on employment income tops out around 47-49% for additional-rate taxpayers. Capital gains tax on share disposals is significantly lower. The election shifts the bulk of any future growth into the CGT regime, which is almost always the better outcome for the employee - and for the company through reduced employer NICs.

The classic case where the election is *not* obviously beneficial is when the gap between AMV and UMV is very large and the shares may never grow - for example a forced-transfer-at-par bad-leaver scheme issued late in a company's life. Even then, most tax advisers recommend the election because the upside protection outweighs the modest up-front cost.

The valuation work

A Section 431 election is only as good as the UMV figure it is based on. HMRC has the right to challenge the UMV after the fact - typically during a PAYE review or following the company's annual Employment Related Securities ("ERS") return.

A defensible UMV report is structured around four steps:

• Enterprise value - derived from earnings multiples calibrated to listed comparables and recent UK transactions, a discounted cash flow where forecasts support it, or net asset value for asset-rich businesses.
• Equity bridge - net debt, cash, surplus assets and any preference instruments stripped out to arrive at equity value attributable to ordinary shareholders.
• Class waterfall - where the cap table includes preference shares, ratchets or convertibles, the equity value is allocated across share classes using a current-value, option-pricing or scenario-based waterfall.
• UMV per share - the relevant share class value, expressed per share, *ignoring* all restrictions in the articles or shareholders' agreement.

The AMV is then derived from UMV for cross-check and disclosure purposes, but the election itself uses the UMV. The two figures must not be confused: AMV is the floor for an EMI exercise price; UMV is the figure on which income tax is paid where a Section 431 election is made.

A contemporaneous, independent valuation report carries materially more weight in a future enquiry than a number calculated by management. HMRC's Shares and Assets Valuation team will accept either, but a report prepared at the time, by a third party, and supported by transparent comparables is much harder to dislodge.

When the election does not apply

Section 431 is only relevant where shares are acquired *by reason of employment* and *are restricted securities* at the time of acquisition. It does not need to be considered for:

• EMI option exercises - shares acquired on exercise of qualifying EMI options are generally outside the restricted-securities rules. The income-tax position is governed by the EMI regime itself.
• Shares acquired before employment - if the shares were already held when the individual became an employee, no employment-related acquisition has occurred.
• Shares acquired at full UMV in cash - no income-tax charge arises on acquisition in any event, so the upside of the election is limited to future restriction-lifting events. Many advisers still recommend it as cheap insurance.
• Unrestricted shares - if the articles and shareholders' agreement contain no restrictions that meet the ITEPA definition, the shares are not restricted securities and the election is unnecessary.

The middle category - shares paid for at full UMV - is the most commonly missed. Even where the employee writes a cheque for the full unrestricted value, a Section 431 election is good practice because it locks the position against later argument that the price paid was below true UMV.

Common mistakes

The single biggest cause of disputes is the missed deadline. The single biggest cause of value disputes, where the election was made on time, is the absence of a contemporaneous independent UMV report.

Worked example

A UK software company issues 200,000 ordinary shares to a senior hire on 1 March. The articles include standard good-leaver and bad-leaver provisions, transfer restrictions requiring board consent, and pre-emption rights tighter than the statutory baseline.

• The valuer derives a UMV of £2.00 per share from a backsolve off a recent Series A round, applying the equity waterfall to the ordinary class.
• AMV is calculated at £1.70 per share after a 15% restriction discount.
• The employee pays £0.50 per share (legacy founder pricing carved out by the board) for the 200,000 shares.

Without a Section 431 election:

• Income tax at acquisition on (AMV - price paid) = £1.20 x 200,000 = £240,000 taxable as employment income.
• The £0.30 per share UMV/AMV gap and all future growth are caught by Chapter 2 - on a future sale at £10 per share, the income-tax slice could run to roughly £1.7m.

With a full Section 431 election signed within 14 days:

• Income tax at acquisition on (UMV - price paid) = £1.50 x 200,000 = £300,000 taxable as employment income.
• All subsequent growth from £2.00 to the eventual sale price is capital gain, taxed at the prevailing CGT rates with no employer NICs.

The election costs the employee an extra £60,000 of acquisition value in the income-tax base and saves the parties materially more on any meaningful exit. In almost every realistic growth scenario the election is the better answer.

FAQ

Related guides

• UMV vs AMV explained - the two values that underpin every Section 431 calculation
• What is HMRC SAV? - the team that reviews UMV figures post-acquisition
• EMI valuation guide - how Section 431 fits into the wider equity-incentive workflow