The Statutory Open Market: Case Law - Shareholders' / family agreements
Sometimes shareholders enter into agreements with other shareholders, family members or with third parties which, depending on the statutory context in which the valuation has to be considered, may affect the value.
Executors of MacArthur (deceased) v Revenue and Customs Commissioners SpC 700;  STC (SCD) 1100
This case involved a valuation of shares for Inheritance Tax (IHT) purposes. At his death the deceased owned minority shareholdings in three family companies. During his lifetime the deceased had made loans to two of those companies which were outstanding at his death. The deceased had an option agreement to convert the loans into ordinary shares, which if converted would have given him control of two of the companies. Whilst the option agreements might be regarded as personal to the deceased, because IHT is charged on the value of a person’s estate, it was decided that the unit of valuation was the shares in each company plus the relevant conversion rights or options. The valuation was calculated on the basis that the shares and conversion rights under the loan agreement would be sold together as a package.
It is important for valuers to remember that the IHT legislation envisages a sale of all the property in the person’s estate and that rights under a shareholder or family agreement are property for IHT purposes (s.272 IHTA includes in the definition of ‘property’ “rights and interests of any description”) which are capable of having a value in themselves or of enhancing the value of assets to which they relate when valued together. The Estate Duty cases of Attorney-General of Ceylon v Mackie  2 All ER 775, Duke of Buccleuch v IRC  1 AC 506, and IRC v Gray  STC 360 all considered the splitting and joining of property in the way that brings the best price. In particular IRC v Gray considered the ability to value quite different types of property together (in that case, an interest in land and a partnership interest). Lord Hoffmann said:
“The principle is that the hypothetical vendor must be supposed to have ‘taken the course which would get the largest price’ provided that this does not entail ‘undue expenditure of time and effort.’ In some cases this may involve the sale of an aggregate which could not reasonably be described as a ‘natural unit’. Suppose, for example, there is evidence that at the relevant time a prudent seller would have discovered that a higher price could be obtained by the combined sale of two items which might otherwise have been thought entirely unrelated to each other. Such circumstances might arise from the peculiar demands of a small number of potential buyers or even those of a single one. In my view the hypothetical seller would in those circumstances have been, subject to the caveat I have mentioned, willing to sell the items together. The fact that no one would have described them as a ‘natural unit’ is irrelevant.”
For IHT purposes a chargeable transfer is a transfer of value by a person as a result of which the value of his estate is reduced. In some circumstances the loss to a person’s estate resulting from a transfer will be greater than the value of the property that has been transferred:
A owns 60 shares in X Ltd. The issued share capital of X Ltd is 100 shares so A has control of the company. A gives 20 shares to B
As the gift causes A to lose control of the company, the loss to A’s estate (the difference between a control holding of 60 shares and a minority holding of 40 shares) is much greater than the value of 20 shares by themselves.
X holds a control shareholding in company Z Ltd which he wishes to transfer to his son. The son acquires X’s shares in exchange for loan notes in the company with a face value of £1m. X later gives the loan notes to his son. The open market value of the loan notes in isolation is much less than face value because they are unsecured, do not bear interest and cannot be redeemed for 50 years. However before the transfer X and his son entered into a family agreement which would enable X to redeem the loan notes in a much shorter period. The arrangement is personal to X and is unassignable. However in ascertaining the loss to X’s estate for IHT purposes, it has to be borne in mind that the terms of the family agreement enhance the value of the loan notes in X’s hands. In gifting the loan notes X’s estate has reduced by much more than the value of the loan notes valued in isolation. The loss to X’s estate in this case is much closer to the face value of the loan notes.
For tax purposes other than IHT it is unlikely that personal rights under shareholder/family agreements will need to be taken into account but it will depend on the particular legislation that applies.
Gray’s Timber Products v HMRC  UKSC 4
This case involved a valuation of employment related securities under Part 7 of the Income Tax (Earnings and Pensions) Act 2003. Under a shareholders’ agreement, the managing director was entitled to a larger part of the consideration from the sale of the company than the proportion that would be due otherwise for his percentage shareholding. In determining whether the managing director’s shares were sold for more than market value it was decided that the rights under the agreement, even had they been set out expressly in the articles of the company, were personal to the managing director. As such they could not be attributed to the hypothetical open-market vendor and could not benefit the hypothetical open-market purchaser. The director’s rights under the shareholders’ agreement were left out of account in calculating the market value of the director’s shares; the enhanced sum he received over market value was charged to income tax and national insurance rather than lower rated capital gains tax.
Cases involving side agreements will require close working with the instructing office to establish the valuation requirement. Valuers should draw such cases to the attention of their G7 who will consult the LTAT as necessary.