The Wonderland of share valuation

SHARE VALUATION
The Wonderland
of share valuation
20 TAXADVISER – August 2009

SHARE VALUATION
By 2003, the government had
tired of what it perceived as
large-scale tax avoidance by
means of low-value shares and options
made available to employees, a
position it resolved to change when it
enacted the wide ranging provisions of
FA 2003, Sch 22, including what is
now Part 7 of ITEPA 2003. I cannot
comment on the tax implications, but
as someone who specialises in the
valuation of shares for purposes that
include employment-related securities,
it seems to me that, as Alice in
Wonderland might have put it, these
days one doesn’t know what is and
what isn’t.
The previous valuation rules had
been with us for many years, and were
reasonably well understood. Employees
Salmon, Patrick v Burrows, and Ede v
Wilson and Cornwall, 2 and depended on
what the shares were worth to the
actual recipient rather than some
anonymous acquirer, which meant that
personal characteristics, and
information actually known by the
recipient, were to be taken into
account.
Occasionally, the different valuation
approaches would produce different
results. In one case where shares were
issued to both shop-floor workers and
management, a higher value applied to
the management shares because they
were aware of an offer for the company,
while most members of the workforce
were not. In most cases, however, there
would be very little, if any, difference in
value, whichever basis applied, but
on principles consistent with the
requirements of ICTA, s. 19, the
so-called ‘normal rules charge’, and
Weight v Salmon etc remain in force.
Part 7 of ITEPA deals with
‘Employment Income: Income and
Exemptions relating to Securities’,
which would seem to comprise a ‘profit
or incidental benefit of any kind
obtained by the employee if it is money
or money’s worth’ referred to in
s. 62(2) above, and includes
employment-related securities. Section
421 in Part 7, Chapter 1 clearly states
that in Chapters 1-5 of Part 7, ‘market
value’ has the same meaning as it has
for the purposes of Part 8 of the TCGA,
ie, TCGA, s. 272. Therefore, it would
seem that, while employee shares are
valued under s. 62 on the money’s
David Bowes examines some of the valuation issues that have emerged as
a consequence of the changes to the employee shares regime
who received rights or interests in
shares, usually options, would pay
income tax on the ‘market value’ of the
underlying shares, defined by what is
now TCGA 1992, s. 272, less any price
paid. Market value envisages a sale in
the open market between hypothetical,
willing, anonymous, parties. While
rights and restrictions contained in the
relevant company’s articles of
association would be taken into
account, shareholders’ agreements or
other personal or collateral agreements
were ignored. 1 In general terms, for
minority holdings of such shares, the
information to be taken into account in
the valuation is published information
only.
If employees actually received shares
by reason of their employment, the
Schedule E charge to tax arose under
TA 1988, s. 19 and s. 131. Market value
was nowhere mentioned in the
legislation, and any tax was due on the
difference between the ‘money’s worth’
of the shares, and what the employee
paid for them, if less. Money’s worth
was determined in accordance with the
decisions in cases such as Weight v
most importantly, there was relative
certainty as to which one would apply,
and what the consequences would be
in valuation terms.
ITEPA 2003 – plus c’est la
même chose
FA 2003, Sch 22 changed all that.
Income tax is now chargeable under
ITEPA 2003, s. 6 on employment
income, stated in s. 7 to include
‘earnings’ within ITEPA, Part 3, Chapter
1, which in fact comprises only one
section, s. 62, and which purports to
explain what is meant by earnings ‘in
the employment income Parts’,
presumably Parts 2-7 of ITEPA. Such
‘earnings’ include ‘any gratuity or other
profit or incidental benefit of any kind
obtained by the employee if it is
money or money’s worth’ in
accordance with Chapter 1, Part 3.
Money’s worth is defined by s. 62(3) as
something either ‘of direct monetary
value to the employee, or capable of
being converted into money or
something of direct monetary value to
the employee’. That suggests that the
basic income tax charge seems to arise
worth basis, as is the position with
other non-monetary assets, they also
confusingly fall within the s. 272 basis
because of the requirements of Part 7.
ITEPA 2003 – plus ça change
Part 7 disconcertingly creates this
previously unknown asset – the
‘restricted’ security or interest in
securities (s. 423) – and also seems to
require determination of its value under
s. 272. Restrictions on shares are
something that valuers have been very
familiar with for as long as private
companies have existed. After all, many
companies subject their shares to them
in their Articles of Association.
However, in Part 7, if as a result of the
restrictions the value is less than it
would be but for them, all restrictions,
whether the subject of any contract,
agreement, arrangement or condition,
have to be taken into account in
valuing these restricted shares. Despite
the fact that, in determining the
market value of restricted securities, s.
421 prescribes the market-value basis,
that brings into the equation all
limitations imposed by the personal
TAXADVISER – August 2009 21

SHARE VALUATION
SAV seems to have found a solution to the problem
created by this very complicated piece of legislation
and collateral agreements referred to in
the third paragraph above, which are
normally excluded from consideration
under s. 272.
ITEPA 2003 – down the
rabbit hole
So the question is – are we valuing
under s. 62 or s. 272? It appears that
Shares and Assets Valuation of HMRC
(SAV) think we are under s. 272 because
in effect they have told us so. In
response to FAQ1(K), namely, ‘Market
value is now based on the CGT
definition. Does this mean that personal
restrictions on the share no longer have
to be taken into account in arriving at its
value?’ HMRC said: ‘No. Even where
there is, for example, a restriction on
sale, the shares must be valued as if that
restriction would still apply to their
hypothetical purchaser. It is the asset (as
it is) that is being valued, not some
other unrestricted asset.’ The
hypothetical purchaser does not exist
except for valuations under s. 272, so
seemingly we are valuing on the basis of
a sale to a hypothetical purchaser who
may have to submit to personal
restrictions imposed on someone else.
To add to the confusion, in order to
obtain CGT treatment of any future
disposal proceeds, shareholders can
elect under s. 431, resulting in tax being
paid when the shares are acquired on
the value presuming that the restrictions
do not apply – the unrestricted market
value (UMV). As s. 431 is within Part 7,
and clear reference is made thereto on
that section, it seems that s. 272 must
also apply in determining UMV. We
therefore have the almost completely
contradictory positions, namely that for
restricted shares under s. 272 we have
regard to otherwise irrelevant
restrictions, in arriving at what is
somewhat erroneously described as
actual market value (AMV), and for
UMV, also under s. 272, we completely
disregard the existence of any
restrictions at all.
And what, in the meantime,
happened to the money’s worth
valuation test in s. 62, seemingly
usurped by market value in Part 7? The
reports of its death seem to have been
greatly exaggerated. The Share Schemes
Manual at 70210 states that ‘normally
the money’s worth and the market value
per TCGA92/s. 272 will be the same.
Where market value exceeds money’s
worth value there can be an additional
charge under Chapter 3C on the
excess’. The Shares Valuation Manual at
109030 states that: ‘In practice most
employers and employees elect out of
the money’s worth basis of valuation for
a full UMV. Where the UMV is seemingly
less than the money’s worth value, the
case should be referred for advice.’ The
implication of that seems to be that the
money’s worth basis takes precedence,
unless the market value, namely the
alternative one that ignores all
restrictions, is greater.
Curiouser and curiouser
If all restrictions are to be regarded,
including personal ones, perhaps that
could only really be achieved using the
money’s worth basis. It would follow
that this basis might apply for the AMV
of restricted shares, notwithstanding
the apparent application of the s. 272
value instead, although some
illogicalities might then arise. While the
legislation is aimed at restrictions, the
money’s worth basis also embraces
shareholders’ rights. If the particular
recipient had inside information
relating to the company’s future
prospects, for example, that could
result in the restricted shares being
worth more than on a s. 272 basis,
surely not what was intended.
According to the Share Schemes
Manual 220020, the position is as
follows: ‘The charge on acquisition of
securities is still often the money’s worth
charge under ITEPA, s. 62, unless an
election under s. 431 is made for the
unrestricted market value to apply…..
Where restricted securities are involved,
the unrestricted market value will usually
be higher than the money’s worth or
CGT values, which take account of the
restrictions.’
As already stated, normally the
money’s worth and the market value will
be the same, but according once more
to the Share Schemes Manual at 20510,
where they differ, any additional value
over and above the money’s worth value
is chargeable under Chapter 3C of Part
7, which is concerned with securities
acquired for less than market value, and
is a sweeping-up provision. Accordingly,
most other provisions take priority over
it, including a money’s worth charge,
unless the amount charged under
Chapter 3C would be greater than that
charged under any of those provisions,
in which case the excess is chargeable
under Chapter 3C.
Through the keyhole
As stated at the outset, before ITEPA, we
seem to have had two valuation bases.
The money’s worth basis applied only
for Schedule E. Market value, whether
under s. 272 or s. 160 for IHT, applied
for everything else. Notwithstanding the
references in ITEPA Part 7 to market
value, as understood for almost all other
tax purposes it does not seem to apply
for employment purposes. Instead,
there now seem to be two new assets,
unrestricted shares to be valued
ignoring all restrictions whatsoever, and
restricted ones that are valued subject
to all possible ones.
At least SAV seems to have found a
solution to the problems created by this
very complicated piece of legislation.
Given the potential difficulties in valuing
the fictional AMV, their solution has
become one of using normal rules while
paying heed to all the restrictions, thus
arriving at a heavily discounted figure
for AMV with which valuers would be
reasonably comfortable, and adding a
small premium thereto in order to arrive
at UMV.
A solution that is arguably certainly
not beyond criticism in pure valuation
terms, it represents a pragmatic solution,
preferable to the Mad Hatter’s tea party
that it once threatened to become.
David Bowes is a chartered tax adviser.
He is a partner in Bruce Sutherland &
Co, the share valuation specialists, and
can be contacted at david.bowes@
bruce-sutherland.com; 01608 651091
1. A-G v Jameson [1905] 2 IR 218, IRC v
Crossman 15 ATC 94, HL, Lynall, Re,
50 ATC 347, HL, and others
2. Weight v Salmon 14 ATC 47, HL,
Patrick (Inspector of Taxes) v Burrows
(1954) 35 TC 138, Ede v Wilson and
Cornwall [1945] 1 All ER 367
22 TAXADVISER – August 2009