Grays Timber Products Limited v Her Majesty’s Revenue and Customs (Scotland)

This appeal concerned whether a disproportionate payment to an employee-vendor on a sale of shares was taxable as employment income under Chapter 3D of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) or instead constituted a chargeable gain. The statutory question turned on the application and construction of Chapter 3D (sections 446X–446Z) and, in particular, on the meaning and application of "market value" as defined by reference to the Taxation of Chargeable Gains Act 1992 (sections 272 and 273).

The court held that the market-value exercise requires focus on the asset acquired by the hypothetical purchaser: the rights attaching to the shares as they would be held after the notional open-market sale. The special contractual entitlement of the employee (the subscription/shareholders' agreement giving him a disproportionate share of the sale proceeds) was personal to him and did not enure to the purchaser. Even if treated as intrinsic to his holding, it had no value to the hypothetical purchaser and therefore did not increase the market value of the shares for the purposes of Chapter 3D. Chapter 3D therefore applied and the excess over market value was employment income subject to income tax and national insurance.

The claimant (Timber Products) appealed against a determination that a sum paid to its managing director, Mr Gibson, on the sale of his shares in the group company was taxable as employment income. The payment derived from the terms of a subscription and shareholders' agreement that gave Mr Gibson a disproportionately large share of the sale proceeds when the group's ordinary shares were acquired by Jewson Ltd in November 2003. Timber Products contended that the extra payment should be treated as a chargeable gain rather than earnings.

• Nature of the claim: HM Revenue & Customs sought assessment for income tax and national insurance contributions, invoking Chapter 3D of ITEPA 2003. Timber Products appealed that assessment.
• Procedural posture: A Special Commissioner dismissed the appeal (decision released 21 March 2007). The Extra Division of the Inner House (majority) dismissed Timber Products' appeal on 13 February 2009 ([2009] CSIH 11). Timber Products appealed to the Supreme Court.
• Issues framed: (i) Whether Chapter 3D of ITEPA 2003 applied so that the excess of consideration over market value counted as employment income; (ii) the correct approach to "market value" for unquoted shares — whether personal or extrinsic contractual rights in the subscription agreement should be treated as part of the asset to be valued; (iii) whether "market value" should be interpreted consistently across Part 7 of ITEPA 2003.

The Supreme Court reviewed the statutory text of Chapter 3D (sections 446X–446Z) and the definition of "market value" in the Taxation of Chargeable Gains Act 1992 (sections 272–273), and considered authorities on valuation of shares where restrictions or personal rights exist. The court emphasised that the hypothetical purchaser in the market-value exercise takes the shares subject to their post-transfer position; rights that are personal to the vendor and do not survive to the purchaser are irrelevant because they produce no value to that purchaser. The court rejected the appellant’s broader submission that extrinsic contractual rights should be treated as enhancing market value for Chapter 3D, and declined to admit an entirely new argument that the subscription agreement was itself an employment-related security. The Supreme Court therefore dismissed the appeal, holding that the excess was caught by Chapter 3D and taxable as employment income.

This was an appeal from the Inner House of the Court of Session. The appeal is dismissed. The Supreme Court held that Chapter 3D of ITEPA 2003 applied: the excess of the consideration over the statutory market value of the employment-related securities counted as employment income. The special contractual entitlement under the subscription agreement was personal to the employee and either did not form part of the asset acquired by the hypothetical purchaser or, if treated as intrinsic, produced no value to that purchaser, and so did not increase market value for the purposes of Chapter 3D. A novel argument that the subscription agreement was itself an employment-related security was refused for admission.

Appeal to the Special Commissioner dismissed by decision released 21 March 2007. Appeal to the Extra Division of the Inner House dismissed on 13 February 2009 ([2009] CSIH 11). Appeal to the Supreme Court dismissed ([2010] UKSC 4).