Chapter 3D levies income tax where the consideration for employment-related securities exceeds their market value. The rules for market value mean that employee-specific provisions are unlikely to be reflected and therefore unexpected charges to income tax can arise. Income tax can also arise under Chapter 3D on differential consideration.

Differential consideration arises when shareholders receive consideration by way of different asset classes or differing amounts of consideration on a transaction. Income tax may be payable under Chapter 3D if the proceeds for employment-related securities exceed those received by other shareholders.

• Income tax likely payable: The proceeds for employment-related securities (either via the same or different asset classes) have a value in excess of that received by other shareholders
• Income tax not likely payable: The proceeds for employment-related securities are delivered via different asset classes to other shareholders but with an equivalent value

A number of tax-advantaged share schemes are available in the UK, for which valuations are required: Company Share Option Plans (‘CSOPs’), Enterprise Management Incentive Plans (‘EMI Plans’) and Share Incentive Plans (‘SIPs’).

• CSOPs: A valuation is required to determine the maximum number of shares over which options can be awarded per employee and to verify that the exercise price of the options is such that the plan qualifies for tax-advantaged status. The valuation of the shares must be agreed with HMRC upfront.
• EMI Plans: A valuation is required to determine the maximum number of shares over which options can be awarded per employee and to verify that the exercise price of the options is such that the plan qualifies for tax-advantaged status. There is no requirement to agree values upfront, but an EMI valuation service is offered by HMRC and is used by most companies. Values agreed with HMRC for EMI purposes are often reached in an accelerated timeframe without a full review and have no application for any other purpose.
• SIPs: A valuation is required to determine the maximum number of shares that can be awarded per employee and to determine any income tax charges that may be payable when shares cease to be subject to the plan. There is no requirement to agree values upfront, but a SIP valuation service is offered by HMRC and is used by most companies. Again, values agreed with HMRC for SIP purposes are often reached in an accelerated timeframe without a full review and have no application for any other purpose.

The Worked Examples Group, a joint venture between HMRC and a number of advisors and advisory bodies, has published a series of worked example valuations. It should be borne in mind that these examples do not necessarily reflect the relevant case law or HMRC practice and following them may lead to the payment of unnecessary tax.

What are growth shares?

Growth shares allow the holder (usually an employee) to share in the value of a company, over and above a pre-determined hurdle, which is usually set at a premium to the value of the company at the time the shares are acquired. Growth shares are therefore highly geared and relatively modest changes in the future value of the company can generate substantial increases in their value.

Economically similar arrangements might be delivered by way of joint ownership of shares, through gearing created by shareholder debt or preferred share capital or via carried interest. They may all be valued in similar ways.

Valuation approach

For many years HMRC accepted nominal values for growth shares if the value of the company was below the hurdle at the time of their acquisition. However, several years ago, HMRC changed its approach and it is now well established that growth shares should be valued using an exit based methodology – in other words, on their anticipated future proceeds.

Two methodologies are commonly used. Which is the best guide to value will depend on the fact pattern and it may be that both are suitable:

Expected returns methodology: This methodology lends itself to scenarios where there are clear expectations around performance and routes to a realisation. However, rudimentary models can be overly sensitive to small changes in underlying assumptions.

Option pricing: This methodology lends itself to scenarios where expectations around performance and routes to a realisation are less clear. Option pricing models produce a large range of outcomes generated by a probability distribution, so can be less sensitive to small changes in assumptions. However, they can overvalue as extreme outcomes can skew the result, unless suitable adjustments are made.

Admissible information

The information admissible to most UK tax valuations is governed by the Information Standards. Although the relevant case law suggests that forecast results are not generally admissible in the valuation of uninfluential minority shareholdings, HMRC’s firm view is that they should be used to value growth shares.

The Memorandum of Understanding (“MoU”) between the then Inland Revenue and the British Venture Capital Association of 25 July 2003 provides a safe harbour whereby the unrestricted market value of carried interest will be taken to be a nominal amount as long as certain conditions are met, set out by way of an example. In situations where different conditions apply, but are not materially value-appreciatory, the view might be taken that the ‘spirit’ of the MoU has been met.

Where the necessary conditions are not met, it is necessary to undertake a valuation. For many years HMRC accepted nominal values for carried interest if the value of the fund was below the hurdle at the time of their acquisition. However, several years ago HMRC changed its approach and it is now well established that carried interest should be valued using either an exit based methodology – usually option pricing – or, for a mature fund, an intrinsic value basis.

The Memorandum of Understanding (“MoU”) between the then Inland Revenue and the British Venture Capital Association of 25 July 2003 provides a safe harbour whereby the price paid for employment-related securities in venture capital and private equity backed transactions will be taken to reflect their unrestricted market value as long as certain conditions are met.

The MoU is not a valuation template and should not be followed unless the conditions are met. Where the conditions are not met, the unrestricted market value of employment-related securities can be far in excess of the price paid for them, depending on the terms of the transaction.

Security tokens and utility tokens are often awarded to employees under management incentive plans. Such assets can be valued using traditional valuation methodologies, though care should be taken to fully reflect the inherent volatility and riskiness of these assets.

For UK tax purposes, since many crypto assets are not securities, they do not fall within Part 7 Income Tax (Earnings and Pensions) Act 2003. In this case, charges to income tax are levied by reference to section 62 Income Tax (Earnings and Pensions) Act 2003, based on the ‘money’s worth’ of the crypto assets.

Money’s worth differs from market value as it reflects the asset’s ability to be turned into money in the employee’s hands. It reflects personal rights and restrictions (such as forfeiture provisions on cessation of employment) which are not typically reflected in market value.

HMRC can review valuations of employment-related securities on several occasions, including:

• As part of a PAYE review
• As part of an enquiry into a self-assessment return – if the acquisition of employment-related securities for less than their value has been flagged
• As part of an enquiry into a self-assessment return – if a capital gain has been realised on the disposal of employment-related securities and their acquisition had not previously been reported

The valuation of employment-related securities is also frequently a focus for due diligence.