The decision of the Supreme Court in the case of Grays Timber Products v HMRC (3 February 2010), concerning the application of Chapter 3D of Part 7 ITEPA 2003 (charge to income tax on a sale of employment-related shares for a consideration which exceeds their “market value”) is of interest for the following reasons:
- It is the first occasion on which the Supreme Court has handed down judgments relating to the new rules governing the tax treatment of employment-related shares and securities introduced in 2003. Walker referred to the provisions as “complex and obscure” and expressed the hope that Parliament would find time to review them!
- It is apparent that the answers to FAQs first published on the HMRC website (but since withdrawn) concerning the interpretation of the term “market value” in the context of Schedule 22 FA 2003, now Part 7 ITEPA 2003, were – on the basis of the arguments advanced by HMRC before the Court – incorrect.
- The case related to the meaning of “market value” in the context of a disposal by an employee of shares on a sale of the company where the aggregate proceeds were divided between the holders of a single class of ordinary shares on a basis that the managing director received more per share (and the other shareholders received correspondingly less) pursuant to a pre-existing agreement between a majority of the shareholders. The employee’s right to receive a disproportionate share of the proceeds of sale of the entire share capital was held to be a personal right (and would have been so even if it had been set out in the articles) of no value to a “hypothetical purchaser” (in relation to whom the value of shares in an unlisted company must be determined under the general rules of share valuation). The valuation of the employee’s shares at the time of the sale (for the purposes of Chapter 3D) did not have to take into account the actual sale of those shares at a special price enhanced for reasons related to the employee’s special position as managing director. It is only the terms subject to which the purchaser will take and hold the shares that must be considered. The employee’s special rights were extinguished on settlement of the transaction.
- Owing to the failure by counsel who appeared before the Court of Session to raise it at that earlier hearing, the Supreme Court declined to consider an alternative argument in support of the taxpayer’s case. This leaves open the possibility that in a similar situation the taxpayer might yet succeed on the basis of this alternative argument: namely, that the employee’s entitlement to share disproportionately in the proceeds of sale is itself an “interest in the proceeds of sale of the shares” and therefore is itself a “security” (per s 420 ITEPA 2003) – distinct from the shares themselves – which was disposed of for a consideration not exceeding the “market value “ of that security.
Does the decision have an impact on the tax treatment of the sale by an employee of his interest under a Joint Share Ownership (JSOP) arrangement?
It is of no direct relevance to the JSOP unless, when the company is sold, the aggregate proceeds are intended to be split between the various holders of shares otherwise than on a strictly pro rata basis. In the case of a private company JSOP, the normal intention is that the joint owners of a share will receive their pro rata share of the total consideration, and then split that amount between themselves in accordance with the JOA. The Gray’s Timber decision would be of relevance only if HMRC could that the employee joint owner then receives, for the disposal of his interest, an amount which then exceeds the “market value” of his interest as joint owner.
In our view, the employee’s interest, as joint owner, is itself a “security” which, under the terms of the JOA, will (if and when, for example, the company is sold) be disposed of for a consideration equal to the “market value” of that security. On this basis, the decision is of no relevance or concern in that context.