Court of Sessions confirms poor structuring causes tax hit for selling employee-shareholder on disproportionate sale proceeds.

Summary of Grays Timber Products Limited v HMRC [2009] CS1H 11

Grays Timber promised its managing director ("Mr G") a disproportionate share of sale proceeds on an exit. Their advisers made the mistake of putting the entitlement in a shareholders agreement instead of in the articles of association. When Grays Timber was sold, the purchaser duly paid 25% of the consideration to Mr G for his 5% stake in accordance with the shareholders agreement.

The Court of Sessions upheld an earlier decision of the Special Commissioners in favour of HMRC that Mr G should be assessed to income tax on the sale of his shares at an overvalue. Worse still, the exit meant the shares were readily convertible assets and so the overvalue was subject to PAYE and NIC (including employers NIC).

In assessing the value of shares for the purposes of the over-value charge in Chapter 3D Part 7 ITEPA 2003, the relevant CGT standard is what a hypothetical purchaser would pay for the shares. The case confirmed that one ignores the personal circumstances and rights of the seller. Had Mr. G had a special class of shares in which the articles entitled the holder to the intended proportion of the sale consideration, there would have been no charge. Gray Timber could easily have arranged for the articles to be changed but sadly didn’t.


This decision is no surprise. We have long advised that sale consideration can only be allocated effectively for tax purposes by creating separate classes of shares at the outset. When structured in this way it is clear the entitlement to sale consideration is an inherent part of the rights attaching to the shares rather than a personal right.

Grays Timber as the employer was obliged to pay employees NIC on the over-value assessed to income tax (which is why it brought the case). Purchasers should always seek indemnities against PAYE and NIC liabilities, and in this case the purchaser would have been wise to hold back sufficient consideration to cover the exposure pending settlement with HMRC.

We frequently advise private companies to create special classes of shares which only participate in gains above a specified threshold to replicate options in circumstances where companies do not meet the EMI conditions. This case emphasises the need to specify these entitlements in the articles.