ERSM30310 - Restricted securities: meaning of restricted securities and restricted interest in securities

Employment-related securities, or interests in employment-related securities, are restricted if restrictions have been imposed directly or indirectly by any:

  • contract,
  • agreement,
  • arrangement or
  • condition,

and

  • the restrictions have an effect on the market value of the security (ITEPA03/S423(1)).

Generally, any restriction that reduces the value of a security will be covered by Chapter 2, but the legislation splits the restrictions into three broad categories of restricted securities and restricted interest in securities:

  • ITEPA03/S423 (2) - risk of forfeiture, where the disposal will be for less than the full market value - ERSM30320 
  • ITEPA03/S423 (3) - restriction on freedom to retain or dispose of securities, or to exercise rights ERSM30330 
  • ITEPA03/S423 (4) - potential disadvantage in respect of the securities ERSM30340 

There are special rules where the restrictions are of the type mentioned within ITEPA03/S423 (2) (forfeitable securities, see ERSM30370).

Discussion

Under ITEPA03/S422 Chapter 2 applies both to securities that are subject to restrictions (referred to as restricted securities) and securities where the employee’s interest in those securities is restricted (referred to as a restricted interest in securities).

ITEPA03/S423 provides a wide definition of the term ‘restricted’. The first consideration is whether or not the restriction has any effect on the market value of securities. If the value is not reduced, then even if there is a restriction, the securities are not within Chapter 2.

The effect of a restriction on the market value of a security will depend on the facts of the case. For example a share may be acquired on 1 January 2006 with a restriction that the employee will not be entitled to any dividends for three months. If the company always declares a large dividend on 1 March each year the restriction will have an effect on the value of the share. However, if the company always declares its dividend in June - or perhaps has never declared a dividend - the restriction may well have no effect on the share value at all.

Restrictions can be imposed in a variety of ways and ITEPA03/S423 (1) covers these by referring to ‘any contract, agreement, arrangement or condition’. The restriction can, for example, be in a side agreement; in the contract of employment; or as a condition of the share acquisition.

For example, a company may have one class of shares, and all shares give the holder a right to vote. If the employee has a side agreement under which it is agreed that he or she cannot vote then there will be a restriction on the shares.

In contrast, another company may have two classes of share: ordinary shares (which give the right to vote) and non-voting A shares. If an employee is given a non-voting A share it is debatable whether or not the employee has a share with a restriction (the absence of a voting right) or an unrestricted non-voting share. Provided the non-voting feature is included in the Articles of Association and there is no special mechanism for its removal, such shares may constitute a different class of shares.

Where a class of share has a lower priority in a winding-up than another class of share in a liquidation it is not restricted but just a different class of share.

It may sometimes be difficult to distinguish between a share which has restrictions on its rights and a share which may convert into a share of a different description (see ERSM40000) and you should consult ESSU in cases of difficulty. For discussion of the interaction between the rules for restricted securities and those for convertible securities, see ERSM40030.