Tax on Share Valuations

The recent decision of the Supreme Court in the Scottish case of Grays Timber Products Ltd. v. HMRC concerned the valuation of shares for income tax purposes. It has important tax and company law implications and may have a significant impact on the way in which deals are structured in the future.

Mr Gibson (G) was appointed managing director of Grays Timber Products (Grays) in November 1999. On appointment he entered into a subscription and shareholders’ agreement with Grays’ holding company, Grays Group Ltd. (Group), and with the holders of over 80% of the ordinary shares in Group. Under that agreement, G subscribed £50,000 for about 6% of the ordinary shares in Group. Further, the other shareholders agreed that in the event of a sale of Group, G would be entitled to receive a disproportionate share of the sale proceeds. In November 2003, Jewson Ltd. acquired all the shares in Group and G received just over £1.4m for his shares. This was about £1m more than he would have received had he just been entitled to a proportionate share of the sale proceeds.

HMRC’s ruled that the £1m excess was subject to income tax and NI contributions rather than (as G and Gray argued) capital gains tax. The potential liability primarily fell on Grays, as G’s employer at the time, although ultimately G was liable to indemnify Grays in respect of any liability. Grays appealed against HMRC’s ruling but the ruling was upheld by the Special Commissioners and then by the Court of Session (the Scottish equivalent to the Court of Appeal).

The Supreme Court has now dismissed Grays’ final appeal. In doing so, the Court ruled that the focus had to be on what was being acquired, and paid for, by the purchaser – namely, the rights attached to the shares themselves and nothing else. Although G's right to a disproportionate share of the proceeds had had a value to him, that right was not the subject of the sale and had not been transferred to the purchaser. The right was no more than a personal contractual right against the other shareholders. It followed that it was irrelevant in assessing the market value of the shares and, accordingly, the £1m excess was subject to income tax and NI contributions.

If you would like to know more about the implications of this case, please contact David Dees or Nick Crook.

Filed: 08/03/2010 11:36:59