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Gray Skies Thinking

The employment-related share legislation is notoriously complicated. One of the difficulties is that the simple term "market value" which is at the heart of the legislation is difficult to interpret. In particular, is one confined to looking only at the articles of association or should one also take into account the effect of shareholder agreements?

The question recently came before the Supreme Court in Gray's Timber Products Ltd v HMRC [2010] UKSC 4. The facts were simple. The MD of Gray's had subscribed for ordinary shares on terms that if the company performed well and was sold he would receive a disproportionately large slice of the proceeds. All went well, the company was sold to an unconnected third party and the amount the MD received for his shares was about £1m more than what would have been his entitlement on a strictly proportionate basis. The question was – had he received more than their market value (in which case the excess was subject to Income Tax, not CGT) or had the market value of the shares been increased by the terms of the shareholders' agreement?

Reassuringly, the Supreme Court did not find the question an easy one to answer. They were not helped by the fact that the HMRC's arguments before it were in flat contradiction to the answers to FAQs published when the legislation was introduced in 2003. The Court concluded that the FAQs were just plain wrong; that (probably) market value for the purposes of the relevant part of the legislation should not take into account agreements extrinsic to the articles; but that in any case rights which were personal to the vendor and did not pass across to the hypothetical purchaser postulated by the "market value" construct (such as the rights of the MD in this case) could not be taken into account.

In hindsight, what could the MD have done; and what can be done in similar cases? One solution would be to create a class of share having the relevant rights embedded under the articles rather than seek to attach the rights to ordinary shares via a shareholders' agreement. Certainly the embedded rights would in principle affect the value to be attributed to the shares on issue; and care would need to be taken in designing the shares so as to ensure that any subsequent enhancement did not trigger a charge under the parts of the regime dealing with restricted or convertible securities. But with care such things can be done.

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