In the landscape of His Majesty’s Revenue & Customs (“HMRC”), Section 431 emerges as a prominent tool for long-term tax strategies pertaining to employment-related securities, specifically, employee stock options. A 431 election (“431”, or “Election”) offers a means to mitigate potential tax liabilities and optimize the treatment or gains arising from such securities, making it part of a valuable tax planning strategy. The question emerges: can the election extend its reach to cryptoassets received as compensation? This analysis navigates the fundamentals underpinning Section 431 while uncovering the complexities entailed in pursuing an Election for compensatory cryptoassets.
The Essence of the Section 431 Election
At its core, Section 431 refers to a provision within the Income Tax Earnings and Pensions Act (“ITEPA”), that provides individuals the opportunity to modify the tax treatment of gains made from employee share options. Employee stock options are a common component of remuneration packages, granting employees the right to purchase company shares at a predetermined price within a specified timeframe. To the employees, the allure of stock options lies in their potential for substantial gains, if the company performs well. Section 431 comes into play when individuals wish to convert the tax treatment of these gains from income tax to capital gains tax, potentially realizing significant tax savings.
Understanding Actual Market Value and Unrestricted Market Value
Central to unraveling the intricacies of the election are the constructs of Unrestricted Market Value (UMV) and Actual Market Value (AMV). These nuanced terms have a significant role in determining the valuation of shares and, consequently, the tax liability of individuals.
- Unrestricted Market Value – the market value of the securities immediately after the chargeable event assuming there were no restrictions on the securities.
- Actual Market Value – the value of a security that considers restrictions imposed on the security. These restrictions encompass elements like the risk of forfeiture, constraints on the freedom to retain or dispose of securities, and potential disadvantages related to the securities (i.e. being excluded for dividends, amongst others).
When individuals opt for the Section 431 Election, income taxes are charged on the difference between UMV and AMV at the time of the grant. Any subsequent growth in value, however, will not be subject to income tax, but rather, will be charged at the capital gains tax rate, potentially realizing significant tax savings.
Applicability of Section 431 Elections on Compensatory Cryptoassets
Similar to granting employee stock options in more traditional industries, blockchain and Web3 companies often issue cryptoassets to key employees to align incentives and achieve a culture of long-term commitment to the venture. It’s therefore tempting to draw a parallel between employee stock options and cryptoasets as compensation and thus surmising that Section 431’s reach extends to cryptoasset beneficiaries. However, a pause is warranted as several factors require further consideration.
What are cryptoassets?
The first major difference is that tokens, unlike employee stock options, are not currently classified as securities. HMRC defines cryptoassets as “cryptographically secured digital representations of value or contractual rights that can be transferred, stored, [and/or] traded electronically.” This definition is broad enough to encompass both Non-Fungible Tokens (NFTs) as well as fungible tokens such as Ethereum, etc.
The Law Commission (“LC”) recently released their final report on digital assets. The Law Commission is the statutory independent body created by the Law Commissions Act 1965 to keep the law of England and Wales under review and to recommend reform where it is needed. Their report concluded that: “the common law of England and Wales is, in general, sufficiently flexible, and already able, to accommodate digital assets”. However, its authors recommend that the law must continue to be flexible and move with the rapidly changing industry of digital assets. In addition, the report states that digital assets are property but fall outside the traditional categories of “chose in action” (that is, rights) and “chose in possession” (that is, physical things). Therefore, they suggest the creation of a third “type” of personal property. If the HMRC adopts the view that digital assets should be considered property, the question arises if Section 431 is applicable at all to cryptoassets, considering that this rule is specific to employment-related securities.
UMV and AMV for Cryptoassets
A subsequent layer of complexity lies in gauging UMV and AMV for cryptoassets. Often, tokens earmarked for key employees lack an active trading market, rendering the appraisal of their unrestricted value a complicated endeavor. Determining the UMV of tokens is a highly complex exercise that requires deep industry experience and extensive knowledge of the subject Token and its underlying project. Only a qualified appraiser with vast industry knowledge and experience will be able to produce a defensible valuation report that can support the UMV of the tokens issued. Considerations that are unique to the valuation of digital assets and should be considered in the appraisal include but are not limited to:
- Specific type of token that is being valued (Defi Tokens, Exchange Tokens, Utility Tokens, Governance Tokens, Security Tokens, or Non-Fungible Tokens (“NFTs”))
- Understanding of the underlying technology (L0, L1, L2, Side Chains, etc.)
- The level of decentralization
- Consensus protocols
- Regulatory and legal risks
- Wash trading
- Token restrictions
In addition, there are opposing views on the applicability of token restrictions for Section 431, specifically the restrictions posed by lockup regimes. The lockups imposed on tokens can be contractual, but they can also be embedded in the code of the token itself. Therefore, the asset itself is restricted as opposed to restrictions imposed on a derivative asset. HMRC, at this time, has not provided any guidance on the nuances here between contractual lockups and programmatic lockups. A recent court ruling in the SEC v. Ripple case in the United States did make a specific differentiation between tokens acquired through institutional sales and programmatic sales. It remains to be seen how this ruling is perceived throughout the world and if the different tax jurisdictions agree with this bifurcation. Until clear rules and regulations are in place, it is essential for the token issuers and recipients alike to obtain tax advice from their digital asset tax specialists.
Summing It All Up
HMRC, at the time publishing this article, has not provided specific guidance on the applicability of Section 431 for cryptoassets as compensation. Further uncertainty is created by the fact that HMRC has not taken a position yet on the actual classification of tokens: asset, security or property. In addition, there are valuation-related issues in determining the UMV and AMV of the subject tokens. To determine if a Section 431 election should be considered, one should consult with a tax specialist that can properly assess the specific facts and circumstances presented. If an Election is deemed applicable, one should consult with a qualified appraiser that has deep industry expertise and extensive experience in the digital asset space to obtain a defensible valuation report for tax purposes.
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 HMRC Cryptoassets Manuel, March 30, 2021.
 Law Com No 412: “Digital Assets: Final Report”, June 27, 2023. https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2023/06/Final-digital-assets-report-FOR-WEBSITE-2.pdf