A Restricted Stock Unit (RSU) is a share granted by an employer in the company (or parent company) for which the employee works. RSUs are most commonly seen as part of a compensation package for startup companies, and also commonly seen as part of senior management compensation to tie them to a company for several years.
The share does however come with restrictions for a certain period during which there are limits on what the employee can do with their share. These restrictions can typically last for several years. Typical restrictions could be:
- The share will be forfeited if employment ends within three years.
- The employee cannot sell the share to a third party for one year after receiving the share, but otherwise they have full entitlement to vote and receive dividends.
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Tax on receipt of the RSU
Income tax can arise on the RSU if the RESTRICTED value of the share has a higher value than the employee has paid for it. What does this mean in practice?
This means valuing the share if a willing buyer and willing seller came together to transfer the share.
- Taking the three-year employment restriction, the restricted share would usually be argued to have zero value, as a potential buyer couldn’t force the employee to remain in their job for the whole three year period, and therefore the shares could be lost in that time-period.
- If the restriction is on sale, as in the second example, a suitable discount would be applied. This could be, say, 20% of market value, to account for the enforced holding time. HMRC could challenge this discount at a later date if it is found to be too high.
The amount of tax due is calculated against the restricted value of the share, minus any cost to the employee. Income tax is charged against this figure.
If the employee pays the restricted market value (or more!) then potentially no further tax is payable at any point (see S431 election).
Tax on lifting of the restriction
There is potentially a further income tax charge when a restriction is lifted. This is calculated as the market value of the share (including any further restrictions), minus the value previously used for a tax calculation, minus any payments made by the employee.
Example 1
An RSU is granted with restriction of not being able to sell for 1 Year. The restricted market value was £80 and the employee paid £50.
| Restricted Market Value | 80 |
| Amount Paid | (50) |
| Amount charge to employment tax on grant | 30 |
| Income tax @20% | (6) |
| Net income | 24 |
At this point the employee is charged to income tax on £30. If the employee is a basic-rate taxpayer, the income tax charged would be £6 / £12 (20% or 40% of £30) depending on the tax status of the employee.
If the employee received the RSU for free the employment tax charge would be £80.
On the restriction lifting the share is now worth £200.
| Unrestricted Market Value | 200 |
| Amount paid | (50) |
| Previously charged to tax | (30) |
| Amount charge to employment tax on vesting | 120 |
| Income tax @20% | (24) |
| Net income | 96 |
The amount subject to tax is calculated as £200 – £30 (the previous amount charged to tax) – £50 (cost to the employee) = £120
The actual income tax charged at this time would be £24 / £48 depending on whether the employee was a basic-rate or high-rate taxpayer.
Example 2
An RSU is granted with restriction of having to stay in employment for 3 years. The restricted market value was £Nil and the employee paid £Nil
| Restricted Market Value | Nil |
| Amount Paid | Nil |
| Amount charge to employment tax on grant | Nil |
| Income tax @20% | Nil |
| Net income | Nil |
On the restriction lifting the share is now worth £200.
| Unrestricted Market Value | 200 |
| Amount paid | Nil |
| Previously charged to tax | Nil |
| Amount charge to employment tax on vesting | 200 |
| Income tax @20% | (40) |
| Net income | 160 |
The actual income tax charged at this time would be £40 / £80 depending on whether the employee was a basic-rate or high-rate taxpayer
PAYE
If the share subject to restrictions is a readily convertible asset, (for example it is traded on an exchange or there is an agreement to sell the shares) the employment charge is taken through payroll and charged through the PAYE system.
This means it is subject to income tax withholding and National Insurance deductions as appropriate. The scheme rules may require the employee to pay the employers national insurance. If this is the case the employers NI of 13.8% is deducted from the value of the RSU first and then PAYE applied. Student loan deductions may also be deducted.
| Unrestricted Market Value | 200 |
| Employers NIC (13.8%) | (27.60) |
| Amount subject to Tax | 172.40 |
| Income tax (40%) | (68.96) |
| Employees NIC (2%) | (3.44) |
| Net Income | 100 |
| Student Loan deduction | (9) |
| Net Income post Student Loan | 91 |
Any tax withheld by the company must be repaid by the employee within 90 days otherwise a benefit in kind for the tax will arise.
For this reason the employing company may sell sufficient shares to cover the tax at time of the restriction lifting.
If the shares are not readily convertible assets then the gain needs to be self-assessed on a tax return but may not be subject to class 1 NIC.
Base Cost
Any shares the employee continues to hold will have a base cost equal to the amount paid by the employee plus any amounts previously charged to employment minus any amounts paid.
In practice this means the base cost will be the UNRESTRICTED market value at time of restrictions lifting.
S431 Election
At the time of the RSU being granted the employee can pay the tax equivalent to the RESTRICTED market value and make a s431 election. This means no further income tax is due. The base cost of the share is the restricted market value.
The benefit is that the income tax is substantially reduced if the value of the share goes up. The downside is finding the cash to pay the tax when you have no asset. Also, if the share price goes down then the tax is not refundable.