.png)
.png)
A trading limited company currently has an agreement stating that the value of any minority shareholding for the purpose of any share transfers will be its ‘fair value’.
This would produce a value of approximately £20 per share based on dividend yield. There are a number of shareholders, including some who are connected to each other and some who are also directors.
One director/shareholder works full time in the business.
The directors are looking to adopt new articles of association and a shareholders’ agreement stating that the value of any minority shareholding will be based on the value of the company as a whole and the relevant percentage shareholding applied thereto. This would probably produce a value of £200 per share.
Numerous questions come to mind, including the following.
- What, if anything, are the PAYE implications? Is a report required on a form 42 and, if so, under which section on the form?
- Is there a transfer of value for inheritance tax purposes; if so, presumably business property relief will be available?
- Is there a deemed gift for capital gains tax purposes?
We would be very interested in hearing readers’ thoughts on these or any other related considerations or suggestions.
Query 17,484 –Minor Holder.
Reply from Nick Gardner, Ashurst LLP
Based on the information provided, the amendment to the articles and the shareholders’ agreement would appear to increase the value of each shareholder’s holding.
The question does not state the circumstances in which shareholders will be paid fair value for their holding. In practice, this is often limited to circumstances where there is either an offer for 50% or more of the share capital of the trading company or an employee or director leaves employment with the company by reason of ill health or retirement.
Sometimes an employee benefit trust is set up to purchase shares at the fair value to increase liquidity.
This is relevant to determining the increase in value of the shares because the valuation of the holding following the amendment will depend on how easy it is for a shareholder to realise the "fair value" (i.e. is this only possible on the occurrence of specified events?).
Following the case of Gray’s Timber Products Limited v CRC [2009] STC 889, the rights should be carefully drafted in the articles of association of the company to ensure that the value is reflected in the shares.
From an income tax perspective, the shares held by employees or directors of the company will be employment-related securities. The amendment of the articles may be something done otherwise than for genuine commercial purposes which would give rise to a charge for such persons under ITEPA 2003, Part 7 Ch 3B.
The reason for the charge is not given in the question, but if either there is no commercial purpose to the arrangement or one of the main purposes was the avoidance of income tax or National Insurance contributions, Chapter 3B would be an issue.
If this section applied, there would be charges to PAYE and employee’s and employer’s National Insurance contributions. If a charge arises under this section, then it should be reported in section 3g of Form 42.
The directors should also consider whether the amendment would be a post-acquisition benefit from securities which would give rise to a charge under ITEPA 2003, Ch 4 and would need to be reported in section 3e of Form 42.
Since the amendment affects the rights of the shares, this should not be a benefit which in my view would be a right separate from the rights inherent in the shares.
There can only be a transfer of value for inheritance tax purposes if the value of any shareholder’s holding is reduced by virtue of the amendment.
On the basis of the description above, the amendment only results in an increase in the amount paid as fair value on a transfer of shares in accordance with the articles.
Unless the effect of this amendment is to impose an obligation on other shareholders to fund the purchase or it were to have a detrimental impact on the value of, for example, a majority shareholder’s shareholding, it is hard to see how such an amendment could result in a decrease in the value of any of the other shareholders’ shareholdings.
Even if there was a transfer of value, as mentioned in the question, business property relief may be available to exempt some or all of the transfer of value.
From a capital gains perspective, either the amendment will not be a disposal or if the amendment creates a new class of shares, the amendment should be treated as a reorganisation of share capital under TCGA 1992, s 126 and there would be deemed to be no disposal (assuming that the amendment is made to all shares of a particular class).
If a single shareholder has control of the company and exercises control so that the value passes from his shareholding or a shareholding of a person connected with him into other shares, there may be a deemed disposal under the value shifting provisions in TCGA 1992, s 29.
However, if as discussed above, the proposed amendments do not result in a reduction in value of any shareholder’s holding, this would not be an issue.
Reply from Thicket
A ‘fair’ value for any particular holding of shares in an unquoted company may have a wide range and much will depend on the reason for the valuation.
Certainly it is not the same as a ‘fiscal’ valuation which has its own rules and precedents from legislation and case law; a ‘fair’ value is not so constrained. It may be that the difference in values is not as pronounced as is suggested.
Even a full valuation with no discount for minority size will need to take account of the lack of market for the shares – or is a bid imminent? It is worth remembering that the value of the company as a whole will not change.
The only people to benefit from the change will be minority shareholders who dispose of shares without there being a bid for the whole company (when presumably all shareholders will participate equally).
Any income tax charge would only arise under PAYE if the shares are ‘readily convertible assets’ (RCAs) as defined in ITEPA 2003, s 702. It seems to be accepted that the existence of standard Table A pre-emption rights does not make the shares RCAs.
As any change in value will affect all shareholders, it is unlikely that an income tax charge will arise on employee shareholders under earnings from employment (ITEPA 2003, s 62).
However, if employees acquire shares at the lower value knowing of the imminent change, this might amount to an emolument. The details will be important.
The employment-related security rules in ITEPA 2003, Part 7 contain a number of circumstances when an income tax charge might arise and each of these will need to be analysed.
HMRC tend to argue that all shares in private companies are restricted securities (although this is debateable). The restrictions in ITEPA 2003, s 423 specifically relate to restrictions on rights of disposal and transfer; these are not affected by the proposals, and so there should be no charge under these rules.
ITEPA 2003, s 447 imposes an income tax charge on post-acquisition benefits and it may be thought that any increase in value is such a benefit. HMRC consider that this is a ‘catch all’.
Certainly something will have been done to affect the securities. However, it is worth noting that nearly all the Part 7 charges are avoided where all shares are similarly affected and the company is either employee controlled or held otherwise than for the benefit of employees (see for example ITEPA 2003, s 429 and s 449). The exemption may well apply.
Inheritance tax applies to any reduction in the estate of the donor. The value of the whole company will not have changed and it is difficult to see how the value of majority shareholdings will have changed.
There is no charge to inheritance tax where there is no gratuitous intent (IHTA 1984, s 10). This comes back to the ‘intentions’ of the shareholders.
The usual reason for providing shares to employees and directors is to incentivise them to increase value for all shareholders, and is certainly not intended to be a ‘gift’. Again, the circumstances will be important.
A similar argument might be run to counter any charge under the general value-shifting rules in TCGA 1992, s 29(1). If there is a commercial reason for the change to the articles, etc, then the only reason will be to increase the value of the company as a whole.
Whether a deemed disposal arises under s 29(2) will depend on the facts. Where a shareholder exercises his control over a company to allow value to pass out of his (or a connected persons) shares into other shares or rights over a company he will be treated as making a disposal of those shares at the market value just before the rights passed out.
If there is such a controlling shareholder, I would question whether the proposed change has affected the value of his shareholding. The value of the company as a whole will not have changed, and the value of a majority shareholding (based perhaps on multiple of earnings) will not have changed.
