Chris Barnes, Pavan Singh and Ann Sharpe from KPMG’s Rewards team give an update on securities valuations, in particular management incentive share issues.
Management incentives in the form of share ownership are continuing to be important in the growth profile of Private Equity (“PE”) backed companies. The abolition of the tax reliefs available under Employee Shareholder Status (“ESS”) in the 2016 Autumn Statement has however, limited the options available, especially with regard to pre-transaction agreements with HMRC Shares and Assets Valuation (“SAV”). This withdrawal, together with the abolition of the Post Transaction Valuation Check (“PTVC”) procedure in March 2016, has led to more uncertainty over value. Share valuations are complex and uncertainties over historical valuations can give rise to challenges on sale via tax due diligence (“DD”). It is also important to be aware of SAV’s current view and practice on the application of penalties in relation to valuations.
Shares awarded under ESS on or after 1 December 2016 will no longer qualify for tax reliefs. There are, however, other commercial and efficient methods of awarding shares to key management.
HMRC tax advantaged share option schemes such as Employment Management Incentives (“EMI”) and Company Share Option Plans (“CSOP”) are still available subject to certain conditions and valuations can be agreed prior to their issue. Also the issue of growth shares remains an effective share incentive arrangement in the M&A sector.
As mentioned above, a pre-transaction mechanism for agreeing valuations currently exists for options over shares issued under EMI and CSOP. There is however no such mechanism for the agreement of the valuation of equity issued to employees following the withdrawal of the PTVC procedure. Whilst an incentive to management to build real growth in a business, the actual valuation of growth shares is becoming increasingly complex, with HMRC specifying the consideration of financial forecast information in arriving at the value and also their view on the restriction of the level of minority discount that is applicable where there is a defined potential exit date. (As discussed in the article ‘Valuation trends for issuing shares to employees’ in M&A Matters Spring 2015).
DD exercises often identify tax risks where share valuations have not been carried out/agreed with SAV. Although the PTVC has taken away certainty regarding the value of shares on issue to management, provided that a contemporaneous share valuation is carried out by an independent professional valuer, HMRC should accept that the company employer has fulfilled its obligations under the PAYE legislation in seeking a ‘best estimate’ and any review on DD would be more favourable in terms of tax indemnities not being required. Any future challenge on valuation which increases the tax liability of the employee would be a personal tax liability of the employee themselves rather than an amount assessable on the employer under PAYE and NIC.
Schedule 24 Finance Act 2007 sets out the general provisions for charging penalties where errors have arisen. The view of HMRC of the application of penalties specifically to tax valuation was confirmed at the latest Fiscal Forum meeting, an annual meeting between valuation practitioners and senior members of SAV. The main areas to be aware of are:
The current HMRC stance on penalties demonstrates the importance, for any share award, of documenting a contemporaneous, detailed share valuation using figures that can be substantiated and based on the valuer being given all relevant facts to provide a considered view on value.
Management incentive share schemes play an important role in the maximisation of value in the M&A sector. There are various mechanisms that can be used to provide shares to management and the most appropriate will depend on the individual company’s commercial objectives and also related tax considerations. As part of this planning, valuation is becoming an increasingly complex area subject to HMRC scrutiny and challenge. It is therefore important to seek specialist valuation advice at the time management shares are provided, particularly to avoid issues arising on a future transaction.