In April 2009's Quarterly Bulletin we discussed the decision in Grays Timber Products Ltd which looked at how to determine the market value of a share. That case was appealed to the Supreme Court and judgment was handed down on 3 February 2010.
The case concerns whether it is possible to have regard to rights set out in documents other than a company's articles of association when assessing the market value of an unlisted company's shares. It is also a useful reminder that selling employment-related securities in excess of market value triggers an income tax charge under Chapter 3D of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).
In December 1999 the taxpayer (Mr G) acquired 14,465 ordinary shares in Gray's Group Limited (the Company) by reason of his employment. Shortly thereafter, Mr G, the Company and certain other shareholders (who, together with Mr G, held 84.6% of the Company) entered into a shareholders' agreement which, amongst other things, provided that in the event of a change in control of the Company, Mr G would receive a price for his shares calculated on a formula which would greatly enhance his share of any sale proceeds. Broadly, although Mr G held approximately 6% of the share capital, he would receive approximately 23% of any sale proceeds.
In November 2003 the Company was sold and Mr G received £1,451,172. HMRC contended that because Mr G received a disproportionate share of the sale proceeds, his shares were sold for more than market value, giving rise to an income tax charge. The taxpayer argued that the rights afforded to Mr G's shareholding in the shareholders' agreement should be taken into account for the purposes of calculating market value and therefore the amount received by him did not exceed market value. "Market value" for these purposes has the meaning given by section 272 of the Taxation of Chargeable Gains Act 1992, namely the price which an asset might reasonably be expected to fetch on a sale in the open market.
In dismissing the taxpayer's appeal, the Court held that in determining the market value of a share attention must be focussed on the asset that is being valued and those rights attached to the shares that would be acquired by the hypothetical purchaser. The terms on which the shares were issued to Mr G under the shareholders' agreement, and the subsequent rights attaching to them, were personal to Mr G – they were not provided for in the articles of association, would not be available to a hypothetical buyer and therefore no value could be attributed to them. Accordingly, they did not affect the price that a hypothetical purchaser would be prepared to pay. When an employee shareholder's personal arrangements result in that shareholder receiving a disproportionate proportion of the total consideration, the relevant provisions in ITEPA (in this case, Chapter 3D) will apply.
The Court also called upon Parliament to review the "complex and obscure" provisions of Part 7 of ITEPA. This call is particularly relevant as the Court did not address how its interpretation of market value for the purposes of Chapter 3D should interact with the interpretation of market value of restricted securities. Shares will be restricted for income tax purposes if they are subject to a restriction that reduces market value. But this decision suggests that if the restriction is a personal one, included somewhere other than the articles of association, it might not reduce market value – and so the shares will not be restricted for income tax purposes. An altogether unsatisfactory outcome.