Restricted vs. Unrestricted Shares in the UK: What You Should Know

In Short

• Restricted shares are subject to conditions that may reduce their market value, offering potential tax advantages but carrying risks.
• Unrestricted shares have no conditions, allowing full rights but may result in higher upfront tax costs.
• Employers should weigh the retention benefits and administrative complexity of restricted shares against the flexibility of unrestricted shares.

Tips for Businesses

Carefully consider whether restricted or unrestricted shares best meet your business objectives. Restricted shares can incentivise employee retention with potential tax benefits, while unrestricted shares provide greater flexibility. Ensure clear communication on tax implications and consider administrative factors when offering these shares to employees.

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Table of Contents

• What are Restricted Shares?
• What are Unrestricted Shares?
• Tax Implications of Restricted Shares
• Tax Treatment of Unrestricted Shares
• Considerations for Employers
• Considerations for Employees
• Key Takeaways
• Frequently Asked Questions

Business owners and employees may encounter “restricted” and “unrestricted” shares when discussing share-based incentives or company ownership. Understanding these shares’ differences is crucial, as they impact tax liability and financial planning. Not understanding the distinction between restricted and unrestricted shares can lead to unexpected tax liabilities and hinder wealth planning.

This article explores the key differences between restricted and unrestricted shares, their tax implications, and key employer-employee considerations.

What are Restricted Shares?

Restricted shares are securities subject to certain conditions or limitations that reduce their market value. These restrictions typically fall into three categories:

1. Forfeiture restrictions: The holder may lose beneficial entitlement to the shares under certain circumstances.
2. Limitation restrictions: Restrictions may limit the holder’s ability to dispose of the shares or exercise their rights.
3. Disadvantage restrictions: Disposing of or retaining the shares may disadvantage the holder or a connected person.

What are Unrestricted Shares?

Unrestricted shares have no special conditions or limitations, except those that apply to all shares of the same class. Holders of unrestricted shares have full rights to dispose of shares, receive dividends, and vote without additional constraints.

Tax Implications of Restricted Shares

The tax treatment of restricted shares can be complex and depends on various factors. Key points to consider include:

1. Acquisition: When an employee acquires restricted shares, there may be no immediate tax charge if the shares are subject to forfeiture for five years or less. Otherwise, the employee may be taxed on the restricted market value of the shares at acquisition.
2. Chargeable events: Income tax and National Insurance Contributions may be due when restrictions lift, change, or the shares are sold. The taxable amount is based on the unrestricted market value of the shares and any tax previously paid.
3. Elections: Employees and employers can elect to pay tax upfront on the unrestricted market value, potentially reducing future tax liabilities.
4. Capital Gains Tax (CGT): Any growth in value after income tax has been paid will be subject to CGT when the shares are sold.

Tax Treatment of Unrestricted Shares

Unrestricted shares generally have a more straightforward tax treatment:

1. Acquisition: If an employee acquires unrestricted shares at less than market value, they will typically be subject to income tax on the difference between the amount paid and the shares’ market value.
2. Subsequent events: There are no additional income tax charges related to restrictions being lifted or varied, as these do not apply to unrestricted shares.
3. CGT: Any increase in value from the time of acquisition will be subject to CGT when the shares are sold.

Considerations for Employers

When deciding whether to issue restricted or unrestricted shares, employers should consider:

1. Retention: Restricted shares can serve as a powerful retention tool, incentivising employees to remain with the company for a specified period.
2. Valuation: Restricted shares may have a lower initial value, potentially reducing the upfront tax cost for employees.
3. Administrative burden: Restricted shares require ongoing monitoring and may trigger multiple tax charges over time, increasing administrative complexity.
4. Flexibility: Unrestricted shares offer greater flexibility for employees but may provide less control for the company over share ownership.

Considerations for Employees

Employees offered restricted or unrestricted shares should consider:

1. Risk vs. reward: Restricted shares offer potential for tax-efficient growth but carry the risk of forfeiture or disposal limitations.
2. Cash flow: Tax charges on restricted shares may arise at times when the shares cannot be sold, creating potential cash flow issues.
3. Elections: Carefully consider whether to make a Section 431 election to be taxed upfront on the unrestricted value, weighing the potential benefits against the immediate tax cost.
4. Long-term plans: Consider how long you intend to remain with the company and how this aligns with any restrictions on the shares.

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Key Takeaways

Understanding the differences between restricted and unrestricted shares is essential for both employers and employees in the UK. Restricted shares can offer tax advantages and serve as effective retention tools, but come with additional complexity and potential risks. Unrestricted shares provide greater flexibility but may result in higher upfront tax costs.

If you need assistance in navigating restricted and unrestricted shares, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to solicitors to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions