Beware the nominal tax valuation

Arriving at a "nominal" valuation – often a fraction of a penny per share – can be tempting when granting equity awards to employees. This approach can reduce employees’ cost of entry, lowers income tax and National Insurance liabilities, and maximises the number of shares that can be awarded under incentive schemes like EMI or CSOP.

However, this approach does not align with HMRC’s valuation guidance and carries a material risk of challenge by HMRC or on tax due diligence, with potentially costly and time-consuming tax implications for the employees and their employer.

Introduction

An intrinsic valuation approach effectively assumes that shares, which may have no immediate intrinsic value, also have no potential to generate future returns. In reality, few businesses grant equity to employees with zero expectation of a future return.

HMRC’s have repeatedly stated that, if the structure is intended to deliver future value, a nominal valuation will likely be deemed incorrect.

There are many commercial drivers that may lead employers to seek a low tax valuation of shares when incentivising their employees. For example, a lower valuation can:

• reduce an employee’s cost of entry (if they are required to pay market value for their shares);
• reduce the tax cost to the employee, and potentially to their employer (if they are paying less than market value);
• increase the number of shares that can be awarded within EMI and CSOP limits; and/or
• drive a larger potential future gain, thus increasing the incentivising impact of awards.

These commercial drivers are so strong that many employers may be tempted to conclude that the tax market value of a share is equal to the nominal value of the shares, often a fraction of a penny, and effectively nil.

Failure to use an appropriate forward-looking methodology would be sufficient for HMRC (or a buyer’s tax due diligence advisor) to challenge that the valuer has not captured the full value of that share.

We are increasingly seeing the use of an inappropriate valuation methodology not only being challenged as incorrect but also as not meeting the threshold to be considered a ‘best estimate’ for PAYE purposes. The impact of this can be that any tax and NIC liabilities arising from the undervaluation would remain a corporate exposure of the employer and thus materially higher risk for the company and its shareholders.

In this article, we consider what this conclusion really means, the risks of relying on a nominal valuation for tax purposes, and whether there is a more appropriate methodology that delivers a commercially acceptable, yet supportable result.

Basis of valuation

The legislative basis for valuation is the price that would be agreed in negotiations between a willing buyer and a willing seller acting at arms’ length. In other words, what would a rational third party be willing to pay to stand in the shoes of the employee who is receiving the equity.

Any potential buyer would naturally assess the likelihood and scale of future returns. Specifically, what value could reasonably be expected if the company meets or exceeds its forecast, and how achievable those projections might be.

In virtually all incentive arrangements, the participants must have the opportunity to participate in value, even if that is dependent on the management team delivering or exceeding a stretching forecast. If there is no realistic opportunity for the incentive shares to deliver a return, then one might reasonably ask why the company has gone to the bother and expense of implementing the arrangement in the first place.

For this reason, we have seen HMRC state on multiple occasions, most recently at the SAV Forum on 3rd March 2025, that a nominal tax valuation is not appropriate where there is a potential for a future return to the participants.

Founder shares

When shares in a true ‘start-up’ enterprise are issued to the founders of the business (who will almost certainly be directors or employees) on or shortly following incorporation then it is generally accepted that the tax value of those shares is unlikely to exceed their nominal value.

However, there may be circumstances where this is not the case – for example, where a company is incorporated as an ownership vehicle for an existing business or assets, or where there are already arrangements in place for the funding of that business, which could imply value in the equity.

Where start-up companies invest their bootstrapped funds (e.g. founders’ loans) in growing their teams, products, and IP, value is starting to accrete but is unlikely to exceed the debt incurred to that point. However, once a third-party investor is willing to provide growth funding, this assumption comes under increasing pressure as there is a clear benchmark for value in the equity.

Benchmark transactions

The primary evidence for the valuation of shares in a private company is the presence of recent or anticipated arm’s length transactions in equity in that or another group company.

A valuer can use this as a yardstick even where the transaction is in a different class of equity, provided the transaction price was determined on arm’s length terms (as opposed to a transaction between connected parties where the consideration may not represent market value).

In the context of a start-up or early-stage growth business, investment rounds (from seed funding, through Series A, etc) involving third parties typically provide a strong benchmark for valuation.

Given these investments are typically in a preferred instrument, for example a preferred class of equity with a liquidation preference, it is necessary to perform analyses to quantify the economic and marketability discounts for the incentive class.

HMRC’s approach

In the context of EMI, where it is still possible to agree a valuation with HMRC, we continue to see cases where nominal tax valuations are agreed by HMRC, particularly in ‘low risk’ submissions, which receive very little scrutiny. However, the direction of travel is clearly pointed away from this conclusion, and we are seeing SAV and due diligence increasingly challenging nominal valuations as a matter of course.

As noted above, HMRC’s view is clear that a nominal tax valuation is inappropriate, and therefore, adopting this approach is ever more risky, particularly given the valuation may not be examined for several years, at which point the assumptions within that valuation may be proved to be incorrect.

Even in cases where such a valuation has been agreed with HMRC (for example for EMI or CSOP purposes) we have seen buyers’ tax due diligence advisors challenge those agreements where not all relevant information was provided to HMRC, where such information was incorrect or misleading, or purely on the basis that the incorrect methodology was adopted.

Need help with valuing shares for employee incentives or other purposes? Let our valuation experts help protect you.

Touchstone Advisory is an independent valuations advisory firm comprising a diverse team of skilled professionals with extensive experience from leading ‘Big Four’ accounting firms’ valuations teams.

Within our broad range of valuation credentials, we specialise in valuing shares in private companies for UK and overseas tax purposes, bringing a wealth of expertise across all sectors. Our track record includes successful engagements in agriculture, family businesses, high-net-worth estates, technology, healthcare, manufacturing, energy, and financial services.