The importance of Unrestricted and Actual Market Value for S.431 elections

This post is part of our Entrepreneurial team’s regular series of blogs.

In the world of entrepreneurial tax, abbreviations are much-loved and you may have noticed two that often pop-up: AMV and UMV. These stand for actual market value (AMV) and unrestricted market value (UMV), and understanding these two terms is extremely important if you are considering issuing shares in your Company to your employees.

First, Unrestricted Market Value. HMRC defines this as the market value of securities immediately after a chargeable event assuming that they had no restrictions. Actual Market Value, however, is the value of the shares with restrictions. But what exactly are restrictions and how do you know whether your shares have any?

The legislation splits restrictions into three main categories:

  • risk of forfeiture (where the disposal will be less than for the full market value)
  • restriction on freedom to retain or dispose of securities (for example if Directors are not allowed to sell their shares if they leave the Company)
  • potential disadvantage in respect of the securities (such as if the shareholder does not receive dividends from the shareholding)

Restrictions are set out in the Company’s Articles of Association but can also be found in separate agreements such as subscription agreements and employee share scheme rules. Shares in most private companies are not completely freely transferable, i.e., they are not freely able to be sold. These restrictions decrease their marketability and, therefore, their market value. For this reason, we deduct a percentage (usually 10% according to HMRC accepted practice but this can vary depending on the extent of these restrictions) from the UMV to account for these restrictions and reach the AMV.

AMV and UMV are particularly relevant when issuing shares in your Company to employees if you are also considering whether to enter an S.431 election. Entering this election means that the restrictions are ignored on the shares and so the shares are treated as having been acquired at the UMV. The election must be entered into within 14 days of the employee acquiring the shares.

But why would your employees want to elect for the UMV and possibly pay a higher price or have a greater tax charge when acquiring their shares? Well, by signing a s.431 election and electing to be deemed to have acquired the shares at this higher amount, when it comes to selling the shares any growth in the value will be taxed as a capital gain at the lower rates of 10% or 20% and no amount will be subject to income tax on sale. Any unused annual exempt amount can also be offset against this gain, further reducing the tax due.

Therefore, signing a S.431 election is usually what we would recommend if the shares are expected to grow in value but, of course, this does carry a risk because the shares could fall in value. If you choose not to enter into a s.431 election, you will acquire your shares at the AMV or below, i.e. you will acquire them at a discount. This discount on the UMV will then be subject to income tax at the basic, higher or additional rates (at 20%, 40% and 45% in England and 19%, 20%, 21%, 41% and 46% in Scotland), and the percentage ‘discount’ between AMV and UMV will be taxed as capital on sale. This means a potentially significant income tax charge on that percentage rather than capital gains tax on the whole gain.

Finally, the above transactions will also need to be included upon your Company’s annual ERS return (due 6th July: an important date to note in your calendar.) These forms report events such as employees being granted shares or options, options being exercised, or options lapsing, and you may need to note if an s.431 election has been entered into. When filling out these forms, the AMV and UMV are often also required at grant and/or at exercise. It may be that another valuation is needed to work out the values.

Unrestricted and Actual Market Value are two numbers that you will need to keep in mind when issuing shares in your company. Make sure you are calculating and using them correctly by checking with a member of our team – contact us with any questions.