Valuing Restricted Shares: HMRC Decision

The valuation of private company shares acquired by, and disposed of by, employees is a complex field which has frequently caused confusion and misunderstanding.

There are several different share valuation methods which can be adopted for tax purposes. Which one will apply in a particular case will depend on the circumstances of the event giving rise to the tax charge.

Since 2003, the tax treatment for restricted shares has been governed by Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. This legislation is fairly complex, but to date, few cases on its interpretation have been heard by the tax tribunals. One reason for this might be that companies and employees have frequently entered into section 431 elections (see below), even if only on a protective basis, in order to opt out of the Part 7 regime.

However, share valuation issues were relevant in the recent case of Sjumarken v HMRC [2015] UKFTT 375 (TC). The taxpayer had an interest in more than one of his employer’s incentive plans, but the one which is of particular relevance from the valuation viewpoint was his interest in his employer’s share plan (Share Plan).

After the taxpayer had been made redundant by his employer, certain shares deriving from the Share Plan were allocated to the benefit of the taxpayer.

At the time, these shares appear to have been valued for tax purposes by the employer without reference to any restrictions (resulting in a higher valuation and therefore more tax payable), although the taxpayer was informed by his employer that restrictions continued to apply to at least some of the shares. Evidently, there was some confusion over the extent to which (if any) restrictions continued to apply, and, if so, how this would affect the valuation process. The tribunal concluded that the relevant provisions in the Share Plan were unclear, and that, in practice, the shares were subject to restrictions and should therefore be valued on that basis.

This case is instructive on the following points:

1.       It is crucial that share scheme documents should be clear and unambiguous, and that individual arrangements for particular employees should be communicated fully and clearly to participants, so as to avoid lengthy and time-consuming arguments further down the line.

2.       Similarly, careful records should be kept by the employer regarding the individual arrangements for particular employees, and, in particular, the basis on which valuations are made.

3.       Where restricted shares are involved, a section 431 election might usefully be considered in order to disapply the Part 7 regime. Such an election can sometimes result in a higher upfront tax charge, but it does normally secure greater certainty of tax treatment.