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Employee Reward Structures by Aidan Langley

Aidan Langley, author of ‘Employee Reward Structures’ provides an outline of share valuation issues for employment income purposes.There are, in effect, three different valuation standards used in ITEPA 2003.

First, there is the “money’s worth” valuation that is found in ITEPA 2003, s 62. This is used, for example, to determine the taxable value where an employee receives unrestricted shares.

Second, there is the CGT valuation, which is used, for example, to determine the taxable amount on the exercise of a securities option.

Third, there is the unrestricted market value or UMV, that is used, for example, to calculate the taxable amount on the vesting of restricted securities under ITEPA 2003, s 428(2).

Money’s Worth Valuation

The ‘money’s worth’ value of an asset is its value in the hands of the employee. It is clear from the case law that this is a subjective test that takes account of any personal restrictions attaching to the asset, such as forfeiture conditions attached to shares. This is the case even if the restrictions are personal to the employee. In other words, it takes account of restrictions that would not apply to a purchaser of the shares. Relevant cases include Tennant v Smith 3 TC 158, Wilkins v Rogerson and Heaton v Bell.

The fact that the valuation is subjective also means that the purchaser is deemed to have access to all information about the company that the employee has, including price‐sensitive information that is not in the public domain.

CGT Valuation Methodology

ITEPA 2003, s 421(1) stipulates that market value, for the purposes of ITEPA 2003, Part 7, is the same as it is for capital gains tax purposes.

Using this methodology, the CGT value of a block of shares is the price which those shares ‘might reasonably be expected to fetch on a sale in the open market’ [TCGA 1992, s 272(1)].

There is no discount available for “flooding the market”. In other words, it is not possible to reduce the estimated CGT value because of an assumption that all the shares are being placed on the market at the same time [TCGA 1992, s 272(2)].

The prospective purchaser of the shares is deemed to have all the information that a prudent purchaser would reasonably require in a private arm’s length sale [TCGA 1992, s 273(3)].

The main difference between the CGT value and the money’s worth value is that the CGT value is objective and does not take account of the personal situation of the vendor or the purchaser.

Impact of Personal Restrictions: Unrestricted Market Value

UMV, as used to determine the taxable amount under ITEPA 2003, s 428, is the CGT value immediately after the chargeable event “but for any restrictions” [ITEPA 2003, s 428(2)]. The restrictions that are relevant are ones that reduce the CGT value of the shares [ITEPA 2003, s 423(1)(b)].

This has led some commentators to argue that the only restrictions that are relevant for determining whether shares are restricted securities are those which are inherent in the shares and would bind a prospective purchaser. Restrictions that are personal to the vendor are relevant in determining the money’s worth value of the shares, but not in determining the CGT value. Since they are not relevant in determining the CGT value, they cannot reduce the CGT value.

HM Revenue & Customs do not agree with this argument [HMRC FAQ 1(k)) although their reasoning is far from clearly expressed. The author disagrees with HM Revenue & Customs, but notes that this is a potentially dangerous line of argument to follow.

Take the example of an employee who is awarded shares that are subject to personal restrictions that reduce their money’s worth value. If HMRC are wrong, then the correct technical position is as follows:

• There is a potential general earnings charge on the acquisition of the shares, based on the money’s worth value less any price paid by the employee [ITEPA 2003, s 62].

• The shares are not restricted securities, because the personal restrictions do not reduce the CGT value of the shares.

• Therefore the exemption in ITEPA 2003, s425(2) does not apply, and there can be no chargeable event under ITEPA 2003, s426.

• However, the employee has acquired the shares for less than their CGT value, so the “securities acquired for less than market value” rules apply.

This means that the employee may actually pay more tax than if he had accepted HM Revenue & Customs’ position. This will be the case if the value of the shares fails to increase sufficiently rapidly to cover the notional loan interest charge. If the share value actually falls, the employee may have a notional loan write‐off tax charge under ITEPA 2003, s 446U.

June 2005

Aidan Langley

About ‘Employee Reward Structures

The above article is adapted from ‘Employee Reward Structures’, published by Spiramus Press Ltd. For further information and to order a copy of this title, click here.

About the author>Aidan Langley, has practised as a solicitor and now works for a Big Four accounting firm, advising smaller companies on the design and implementation of short and long‐term reward plans.

About The Author

Mark McLaughlin is a Fellow of the Chartered Institute of Taxation, a Fellow of the Association of Taxation Technicians, and a member of the Society of Trust and Estate Practitioners. From January 1998 until December 2018, Mark was a consultant in his own tax practice, Mark McLaughlin Associates, which provided tax consultancy and support services to professional firms throughout the UK.

He is a member of the Chartered Institute of Taxation’s Capital Gains Tax & Investment Income and Succession Taxes Sub-Committees.

Mark is editor and a co-author of HMRC Investigations Handbook (Bloomsbury Professional).

Mark is Chief Contributor to McLaughlin’s Tax Case Review, a monthly journal published by Tax Insider.

Mark is the Editor of the Core Tax Annuals (Bloomsbury Professional), and is a co-author of the ‘Inheritance Tax’ Annuals (Bloomsbury Professional).

Mark is Editor and a co-author of ‘Tax Planning’ (Bloomsbury Professional).

He is a co-author of ‘Ray & McLaughlin’s Practical IHT Planning’ (Bloomsbury Professional)

Mark is a Consultant Editor with Bloomsbury Professional, and co-author of ‘Incorporating and Disincorporating a Business’.

Mark has also written numerous articles for professional publications, including ‘Taxation’, ‘Tax Adviser’, ‘Tolley’s Practical Tax Newsletter’ and ‘Tax Journal’.

Mark is a Director of Tax Insider, and Editor of Tax Insider, Property Tax Insider and Business Tax Insider, which are monthly publications aimed at providing tax tips and tax saving ideas for taxpayers and professional advisers. He is also Editor of Tax Insider Professional, a monthly publication for professional practitioners.

Mark is also a tax lecturer, and has featured in online tax lectures for Tolley Seminars Online.

Mark co-founded TaxationWeb (www.taxationweb.co.uk) in 2002.