BADR and Section 431 — UK Tax Considerations for Senior Executives

BADR and Section 431: UK Tax Considerations for Senior Executives

Business Asset Disposal Relief (BADR) and Section 431 elections are two of the most important UK tax concepts for senior executives holding equity in growth companies, PE-backed businesses, or pre-IPO firms. BADR can reduce the effective capital gains tax rate to 10% on qualifying business asset disposals — compared to the standard 20% CGT rate — potentially saving hundreds of thousands of pounds in tax on a successful exit. Section 431 elections protect equity holders from unexpected future income tax charges that can arise when restrictions on employment-related shares lift over time.

This guide explains how BADR and Section 431 work, who qualifies, the conditions that must be met, the interactions between BADR and EMI options, and the practical steps executives and their advisers should take to protect the favourable tax treatment of their equity. This is informational guidance and not tax advice — specific situations should always be reviewed by a qualified tax adviser before any equity decisions are made.

Business Asset Disposal Relief: The Basics

Business Asset Disposal Relief — formerly called Entrepreneurs’ Relief before its renaming and reform in the 2020 Budget — provides a reduced CGT rate of 10% on qualifying disposals of business assets, compared to the standard 20% rate (or 24% for residential property). The lifetime limit of qualifying gains is £1 million per individual (reduced from £10 million in the 2020 reform), meaning that BADR saves a maximum of £100,000 in CGT (the 10% saving on £1 million) for any individual over their lifetime.

The conditions for BADR on shares in a trading company require: the individual must be an employee or officer of the company (or a company in the same group); the shares must be “ordinary share capital” (most common share classes qualify, but certain preference share structures may not); the company must be a qualifying trading company or holding company of a qualifying trading group; the individual must hold at least 5% of the ordinary share capital and voting rights (the “5% condition”); and the conditions must have been met for at least two years before the disposal.

EMI Options and BADR

EMI options have a specific BADR qualification route that is more accessible than the standard 5% shareholding requirement. Under the EMI BADR rules, an individual who exercises qualifying EMI options and then disposes of the shares acquired can claim BADR without needing to meet the 5% shareholding threshold, provided: the options were granted at least two years before the disposal; the company was a qualifying company at the date of grant; and the individual has been an employee since the grant date. The two-year period starts from grant, not from exercise — so EMI option holders who exercise and immediately sell on a company sale can qualify for BADR if they have held the options for at least two years.

This EMI BADR route is one of the most valuable features of EMI options as a senior executive incentive instrument. An executive who joined a qualifying EMI company two years before a £300 million exit, holding options over 0.5% of the equity with a total gain of £1 million, could pay CGT at 10% (£100,000) rather than 20% (£200,000) on the BADR-qualifying portion of their gain, saving £100,000 in tax. Ensuring that EMI options are granted at the appropriate time — at least two years before a foreseeable exit — is one of the most important tax planning steps for growing companies.

Section 431 Elections

Section 431 of ITEPA 2003 provides an election mechanism that allows employees to elect for employment-related shares to be treated as acquired at their unrestricted market value, even if the shares are actually acquired at below market value or are subject to restrictions. This election is made jointly by the employee and employer, typically within 14 days of the share acquisition, and it cannot be made retrospectively.

The problem that Section 431 addresses is the “restricted securities” regime under Chapter 2 of Part 7 ITEPA 2003. Where shares acquired in connection with employment are subject to restrictions — forfeiture on bad leaver departure, restrictions on transfer, or other conditions that affect their value — HMRC treats the difference between the restricted value (the price paid by the employee, reflecting the restrictions) and the unrestricted value (what the shares would be worth without the restrictions) as employment income when the restrictions lift. This creates an unexpected income tax charge at the point restrictions lift — which may be at exit when the gain is being realised as a capital gain.

Without a Section 431 election: employee pays reduced price for restricted shares; restrictions eventually lift; difference between restricted value at acquisition and unrestricted value at lifting is employment income; employee pays income tax (up to 45%) on this amount at the point restrictions lift. With a Section 431 election: employee elects to be treated as acquiring at unrestricted market value; any subsequent gain (from unrestricted value at acquisition to disposal value) is entirely a capital gain; no income tax charge arises when restrictions lift.

When Section 431 Elections Are Required

Section 431 elections are particularly important in PE management equity situations where sweet equity shares are acquired at a low value (reflecting the hurdle below which management has no economic interest) and are subject to bad leaver forfeiture provisions. Without a Section 431 election, the difference between the restricted value (which reflects the hurdle, the bad leaver risk, and other restrictions) and the unrestricted value (what the shares would be worth if freely transferable without conditions) is at risk of being treated as employment income when the restrictions lift — which typically happens at the PE exit.

The size of the income tax risk that Section 431 protects against depends on the specific share structure. For sweet equity where the restricted and unrestricted values are broadly similar at acquisition (because the restrictions are relatively minor), the Section 431 protection may be modest. For sweet equity where the restrictions create a large gap between restricted and unrestricted value — as is often the case for growth shares with high hurdles and strict bad leaver provisions — the Section 431 protection can be material.

Interaction with BADR: Maximising Capital Gains Treatment

The interaction between BADR and Section 431 creates a specific tax planning question: if shares are acquired at restricted value (without a Section 431 election), the restricted securities regime may create an income tax charge when restrictions lift, which is then not eligible for BADR. With a Section 431 election, the entire gain from restricted value at acquisition to exit value is a capital gain, eligible for BADR if the qualifying conditions are met.

The optimal outcome — maximising capital gains treatment and minimising income tax — requires: making a Section 431 election within 14 days of share acquisition (to protect the entire gain from income tax); meeting the BADR qualifying conditions (five-year period for sweet equity if the EMI route is not available); and structuring the exit to crystallise the disposal in a qualifying BADR disposal. Each of these steps requires advance planning, and each is much harder — or impossible — to implement after the fact.

Further Reading

The HMRC BADR guidance provides the authoritative framework for qualifying conditions. The HMRC Employment Related Securities Manual covers the restricted securities regime and Section 431 mechanics in detail. Related guides: Sweet Equity for PE Management Teams · Pre-IPO Equity Structuring · Deferred Compensation Buyout

Growth Shares and Section 431: Practical Application

Growth shares — a class of shares that participate in value above a hurdle — are commonly used at PE-backed businesses and pre-IPO companies as an alternative or supplement to options. The Section 431 election is particularly important for growth shares because the restricted value at issue (which reflects the hurdle, the drag-along rights, and the bad leaver provisions) is often significantly lower than the unrestricted market value (what the shares would be worth if freely transferable). Without a Section 431 election, the difference between the restricted value at issue and the unrestricted value at the point restrictions lift — which may be the exit — is taxed as employment income rather than capital gains.

The Section 431 election must be made within 14 days of the share acquisition. This is an absolute deadline — the election cannot be made retrospectively, however compelling the argument that it should have been made. Executives who acquire growth shares or other restricted shares in connection with their employment and who do not make a Section 431 election within 14 days are locked into the restricted securities regime for those shares, with the associated income tax risk that creates. Ensuring that Section 431 elections are filed immediately on share acquisition is one of the most important administrative steps in employment-related share scheme management, and it should be part of every onboarding checklist for executives receiving share-based compensation.

The employer must also file a Section 431 election — it is a joint election requiring both the employee’s and the employer’s signatures. Employers who are not properly advised on employment-related share scheme obligations sometimes fail to file the employer’s side of the election, rendering the election invalid. The Company Secretary or CFO at a business that regularly grants employment-related shares should ensure that the Section 431 election process is properly documented and that compliance with the 14-day deadline is tracked as part of the equity plan administration.

BADR Qualification: The 5% Shareholding Requirement

The 5% shareholding requirement for BADR — that the individual must hold at least 5% of the ordinary share capital and 5% of the voting rights — is a significant practical constraint for senior executives at larger businesses. At a company with a fully diluted share capital of 100 million shares, the 5% threshold requires the executive to hold at least 5 million shares. For executives with options rather than shares, the option shares are not counted towards the 5% threshold until the options are exercised — so an option holder with options over 5% of the company does not meet the BADR qualification requirements based on the option holding alone.

The EMI BADR route — which waives the 5% requirement for qualifying EMI option holders — is accordingly valuable specifically because it removes this barrier for the large population of growth company senior executives who hold option stakes below 5% of the company. The EMI BADR route requires: EMI options granted at least two years before disposal; the company must be a qualifying company at the date of grant; and the individual must be an employee continuously from grant to disposal. Meeting these conditions is typically straightforward for executives who joined early-stage companies on EMI option grants, but becomes more complex for executives who joined at later stages when the company may have grown beyond EMI qualification or when the employment continuity conditions may have been interrupted.

EMI Disqualification Events

EMI options can be disqualified — losing their qualifying status and therefore their favourable tax treatment — if certain disqualifying events occur after the grant. The most common disqualifying events include: the company ceasing to be a qualifying company (typically through exceeding the gross asset or employee count thresholds); the employee ceasing to meet the working time requirement; the company becoming a subsidiary of another company (which typically disqualifies it from EMI, as EMI requires the company to be independent); and certain changes to the terms of the options themselves.

A disqualifying event does not typically cause the immediate loss of all tax benefits on existing options — options that were qualifying at grant retain their EMI status for up to ten years from the date of grant even if a disqualifying event occurs after grant. But options granted after a disqualifying event cannot be qualifying EMI options and must be granted as unapproved options. This means that the equity plan management at growing companies needs to actively monitor EMI qualification status and to plan the transition from EMI to unapproved options proactively rather than reactively.

Interaction with the Annual CGT Exemption

The annual CGT exempt amount — the amount of capital gains an individual can make in a tax year without paying CGT — was £12,300 for 2022/23 before being progressively reduced to £3,000 for 2024/25 onwards. This reduction significantly affects the tax planning for executives with multiple equity positions vesting in close succession, since the reduced exemption means that a higher proportion of each realisation is now subject to CGT than in recent years. For executives with significant pre-IPO equity positions, post-IPO LTIP awards, and PE management equity all vesting in the same tax year — as can happen around major corporate events — the tax planning for timing and allocation of realisations across tax years has become more significant as the annual exemption has reduced.

Exec Capital’s Equity Compensation Advisory Role

As part of Exec Capital’s retained search practice, we provide candidates and clients with context on the tax and financial implications of equity compensation structures — not as tax advisers (we always recommend that candidates and clients take independent specialist tax advice), but as practitioners who have seen many equity structures in many different business contexts and who can help frame the right questions to ask. For executives evaluating complex equity offers — involving EMI options, growth shares, PE management equity, or pre-IPO options alongside or instead of standard LTIP awards — we can help identify the specific tax questions that need specialist advice and can recommend tax advisers with relevant expertise. The companion guides on Sweet Equity, Pre-IPO Equity Structuring, and Co-Investment and Carry provide the full equity compensation context for executives navigating these instruments.

Recent BADR Reforms and the Lifetime Limit

The reduction of the BADR lifetime limit from £10 million to £1 million in the March 2020 Budget significantly reduced the financial value of BADR for the most successful senior executives. At the old £10 million limit, a senior executive with a £3 million EMI option gain could reduce their CGT bill from £600,000 (at 20%) to £300,000 (at 10%), saving £300,000. At the new £1 million limit, the same executive can only claim BADR on £1 million of their gain — saving £100,000 rather than £300,000 on the BADR-eligible portion, and paying 20% on the remaining £2 million of gain. The reform significantly reduced but did not eliminate the financial value of structuring equity awards to qualify for BADR.

The lifetime nature of the £1 million limit requires executives with multiple equity positions — across successive employer equity awards, EMI grants, PE management equity, and entrepreneurial ventures — to manage the allocation of their lifetime BADR entitlement across these positions. Using the entire £1 million of lifetime BADR on a relatively modest gain from a small startup — before a larger gain from a more substantial position has been realised — forecloses the BADR option on the larger gain. Tax planning that considers the likely sequencing and magnitude of qualifying gains is accordingly valuable for senior executives with multiple equity positions, and it should be reviewed periodically rather than treated as a static planning decision.

EMI Share Scheme Valuation and HMRC Approval

EMI option grants must be made at market value — confirmed by a current HMRC-approved valuation — to maintain the favourable tax treatment. HMRC allows companies to apply for advance confirmation of the market value of EMI shares (“HMRC valuation approval”), which provides a 90-day window during which options can be granted at the approved value. Obtaining HMRC valuation approval is standard practice for companies making regular EMI grants and significantly reduces the risk of a subsequent HMRC challenge to the option’s strike price. The valuation methodology should be prepared by a qualified valuations specialist — accounting firms and specialist business valuation practices both provide this service — using the recognised HMRC-accepted approaches (earnings multiples, discounted cash flow, or asset-based methods, as appropriate for the specific company).

Shares Acquired Under Unapproved Options: Tax Mechanics

Shares acquired by exercising unapproved options are subject to income tax and NIC on the option gain at exercise — the difference between the option’s exercise price and the market value of the shares at the exercise date. This income tax charge occurs at the point of exercise even if the shares are not immediately sold; the executive pays income tax on the gain but may not receive cash proceeds until the shares are subsequently disposed of. For executives at PE-backed businesses who exercise options in connection with an exit event — where the proceeds are received immediately — the tax is paid from the exit proceeds and the timing is straightforward. For executives who exercise options in isolation — for example, to start holding period clocks for capital gains purposes — the cash cost of the income tax on exercise may need to be funded from existing resources.

After the income tax charge on exercise, the shares’ cost basis for capital gains purposes is set at the market value at exercise (not the option exercise price). Subsequent disposal of the shares creates a capital gain (or loss) based on the difference between the disposal proceeds and this stepped-up cost basis. BADR may apply to this capital gain if the qualifying conditions — including the five-year holding period requirement or the EMI two-year-from-grant requirement — are met. Planning the timing of option exercise to optimise the combination of income tax on exercise and CGT on disposal — including the BADR qualification clock — is one of the most commercially significant equity planning decisions for executives holding large unapproved option grants.

Non-Domicile Status and UK Equity Compensation

Senior executives who are UK resident but non-domiciled — whose permanent home (domicile) is outside the UK — have historically had access to the remittance basis of taxation, which limits UK tax to UK-source income and gains, and income and gains remitted to the UK, rather than worldwide income and gains. The remittance basis has become significantly more restricted in recent years and is being abolished entirely from April 2025 under reforms announced in the 2024 Autumn Budget, replaced by a new foreign income and gains (FIG) regime. Senior executives with non-domicile status who hold equity compensation should take specific advice on the impact of these changes on their equity positions, particularly where they hold equity in non-UK businesses that generates gains outside the UK.

For equity compensation from UK employer companies, the remittance basis and non-domicile planning considerations are generally less significant because the employment-related securities framework taxes the employment income element of UK equity awards on a UK-source basis regardless of domicile status. The more significant planning consideration for non-domiciled executives relates to their non-UK equity holdings — PE management equity at non-UK holding companies, pre-IPO options in non-UK-incorporated entities, or carry distributions from non-UK funds — where the old remittance basis provided significant tax deferral opportunities that the new FIG regime will fundamentally change.

Growth Shares: HMRC Valuation in Practice

Obtaining an HMRC-approved valuation for growth shares before issue is a critical step in the growth share implementation process. The HMRC’s Shares and Assets Valuation team — which processes valuation submissions for employment-related securities including EMI options and growth shares — accepts valuation submissions through the HMRC Shares Valuation service. The valuation methodology must reflect the specific characteristics of the growth share class: the hurdle level, the drag-along and tag-along rights, the bad leaver forfeiture provisions, and any other restrictions that affect the share’s value relative to the unrestricted ordinary shares. A valuation that understates the growth shares’ market value — setting the issue price below fair value — creates an employment income charge on the discount, negating the tax benefit of the growth share structure.

HMRC turnaround times for EMI valuation submissions and growth share valuation queries vary significantly depending on the complexity of the company and the volume of submissions in the Shares and Assets Valuation team’s queue. Average turnaround times have ranged from eight to twenty-five weeks in recent years, and companies planning time-sensitive equity grants — ahead of a funding round, an anticipated exit, or a planned executive appointment — should submit their valuation requests well in advance of the planned grant date. Where HMRC’s agreed valuation is lower than expected, it may be necessary to revisit the share scheme design to ensure the economic terms remain appropriate given the confirmed valuation.

The BADR and Section 431 landscape has evolved significantly in recent years — with the BADR lifetime limit reduction, the restricted securities regime clarifications, and the EMI disqualification event rules all changing the practical application of these provisions — and will continue to evolve as HMRC and the government respond to the growth of equity compensation at UK growth companies. Senior executives with significant equity positions should ensure their tax advice is current rather than based on the position as it stood at the time of their equity grant. Annual review of the tax position on all significant equity holdings — including reassessing BADR qualification as the facts change, reviewing the Section 431 position on any restricted shares acquired in the past two years, and assessing the impact of any changes in the executive’s employment status on EMI qualification — is the appropriate standard of tax planning stewardship for executives with substantial equity wealth. Exec Capital’s appointments practice includes referrals to specialist tax advisers for executives navigating complex equity tax positions, and our offer construction support includes a specific equity tax briefing that identifies the questions each candidate should be asking their tax advisers before accepting equity-based compensation.