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

For the employment-income charge on securities disposed of above market value, the asset must be valued by reference to the rights which a hypothetical purchaser would acquire. A personal, non-transferable contractual right to an enhanced share of the sale proceeds adds nothing to market value when it is extinguished on completion and does not pass to the purchaser. This remains so even if the right may, in some sense, be described as intrinsic to the shares.

The hypothetical sale is a valuation criterion. Its implications must not be extended by treating the actual sale, or personal benefits received through it, as part of the asset acquired. Each charging Chapter in Part 7 of the Income Tax (Earnings and Pensions) Act 2003 is to be applied according to its own terms.

The appellant company’s managing director acquired ordinary shares in its parent under a subscription agreement. The agreement entitled him, in recognition of his services, to a disproportionately large share of the consideration if the parent was sold. When all the parent’s shares were acquired by an outside purchaser, he received about £1.45m, although a proportionate share would have been under £0.4m.

HM Revenue and Customs treated the excess over the shares’ statutory market value as employment income under Chapter 3D of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. A Special Commissioner dismissed the employer’s appeal. The Extra Division of the Inner House dismissed a further appeal by a majority: [2009] CSIH 11.

The central question was whether the director’s personal rights under the subscription agreement increased the market value of the shares, as defined by the Taxation of Chargeable Gains Act 1992.

1. The appeal was dismissed unanimously. Lord Walker and Lord Hope delivered judgments. Lord Rodger, Lord Brown and Lord Kerr agreed completely with both. The enhanced amount received on disposal exceeded the market value of the employment-related securities and was taxable as employment income under Chapter 3D of Part 7 of the Income Tax (Earnings and Pensions) Act 2003.

2. Under section 272 of the Taxation of Chargeable Gains Act 1992, attention must be directed to the asset requiring valuation. The relevant question is what a hypothetical purchaser would pay for the rights acquired with the shares. The director’s contractual entitlement had value to him, but it did not transmit to the purchaser and was extinguished when the transaction was completed. It therefore had to be disregarded when determining market value.

3. Lord Walker held that the result was the same whether the director’s contractual rights were described as intrinsic or extrinsic to the shares. A right may be personal even if incorporated into the constitution of a company. Because the enhanced payment recognised the director’s personal services, and the right was non-assignable, a hypothetical purchaser would pay nothing extra for it. After completion, every ordinary share acquired by the purchaser had equal value.

4. The authorities concerning restricted shares required the hypothetical purchaser to be placed in the vendor’s position regarding rights and restrictions which continued to affect the acquired property. They did not require personal rights, which would not pass on the sale, to be attributed to that purchaser. Nor should the statutory hypothesis be taken so far as to assume that the contemplated sale had actually occurred. It prescribes an open-market criterion for valuation.

5. Lord Hope held that the common definition of market value did not require every Chapter of Part 7 to treat the same kinds of collateral rights as part of the property valued. Each Chapter should be applied according to its own terms, particularly in view of the anti-avoidance purpose of the substituted provisions. Official answers previously published by the Revenue did not carry sufficient persuasive authority on the precise issue and could not displace the court’s construction.

6. The court refused to entertain a new argument that the subscription agreement was itself an employment-related security. Its consequences had not been explored below, and the proposed argument did not satisfy the test for admitting an entirely new point on a final appeal.

• United Kingdom Supreme Court: Dismissed the appeal unanimously and affirmed the Extra Division’s interlocutor: [2010] UKSC 4.
• Inner House of the Court of Session, Extra Division: Dismissed the employer’s appeal by a majority, Lord Osborne dissenting: [2009] CSIH 11. The judgments were also reported with the Special Commissioner’s decision at [2009] STC 889.
• Special Commissioner: Dismissed the employer’s appeal from HMRC’s revised determination in a written decision released on 21 March 2007.