UK Supreme Court Rules Market Value of Managing Director's Securities Did Not Have to Account for Special Employment-Related Price

Giving an objective meaning to the term market valuation, the UK Supreme Court ruled that a managing director who sold his employment-related securities at a special price pursuant to a subscription agreement when all of the company’s shares were purchased was properly taxed at ordinary income rather than capital gains for the difference between the special price and what a hypothetical purchaser would have paid. Lord Walker for the majority said that market valuation did not have to take account of the actual sale of the director’s shares at the special price enhanced for reasons relating to his special position as managing director.

Whether it was right to say that his special rights did in some sense attach to the shares or not, reasoned the Court, those rights had no value to the hypothetical purchaser. They were rights personal to the managing director and were extinguished by the payment which he received. Thus, the £1m difference between the amount paid for the director’s securities under his subscription and shareholders agreement and what would have been the normal value of his 6 percent stake was subject to income tax under the Income Tax Act of 2003.

Under the Income Tax Act, market value in relation to any assets means the price which those assets might reasonably be expected to fetch on a sale in the open market. In estimating the market value of any assets no reduction can be made in the estimate on account of the estimate being made on the assumption that the whole of the assets is to be placed on the market at one and the same time.

The Court said that the special rights, even assuming they are intrinsic, should not be treated as inuring for the benefit of a hypothetical purchaser. Rather, they should be disregarded as being exclusively personal to the managing director and worthless to anyone else. A shareholder right can be personal even though it is intrinsic, reasoned the Court, since class rights can be enjoyed by a class with only one member. The rights here were non-assignable and peculiar to his position as managing director.

In a concurring opinion, Lord Hope said that in estimating the market value of securities attention must be focused on the asset that requires to be valued, here the rights attached to the shares acquired by the purchaser, no more and no less. Lord Hope agreed with the majority that what has to be considered to determine their market value for the purposes of the statute is what a hypothetical purchaser would pay to acquire those rights at the relevant date.

The managing director’s right to an enhanced payment had a value to him, but that right was not the subject of the transaction as it did not transmit to the purchaser. What the purchaser acquired and paid for was the rights attached to the shares themselves and nothing else. The managing director’s rights under the subscription agreement between him and the other shareholders who were parties to it were given effect when the transaction was entered into, reasoned Lord Hope, but for the purposes of the Income Tax Act of 2003 they must be disregarded.

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