The CooperVision case: Bringing Chapter 3D valuation risk into sharp focus

The CooperVision decision is a reminder that a deal price alone does not eliminate Chapter 3D valuation risk. Where sale proceeds are allocated unevenly between shareholders, the market value of the specific ERS still needs to be supported.

The case also highlights that valuation advice should never be taken at face value; its suitability depends on the quality of the underlying information, and the assumptions and scrutiny applied.

A valuation report will not, in itself, protect an employer against a PAYE exposure or a finding of carelessness.

Case Summary

The FTT has decided in the appeal by CooperVision Lens Care Limited (the "Company") against an HMRC determination that the Company should have applied PAYE and NIC on a proportion of the proceeds received by three of its shareholders (the "Shareholders") on the historical disposal of their shares.

At the time of the August 2014 disposal, two corporate shareholders – Prism and Bond – held a mix of A ordinary shares, preference shares and ordinary shares. The three Shareholders held ordinary shares alongside five other individual shareholders. See Figure 1 of the Illustration for a summary capitalisation table.

The three share classes had very similar economic rights per the Company's Articles of Association and should have delivered capital proceeds close to pro rata to the shareholders.¹

Despite this, the Shareholders managed to convince the other sellers to include a formula in a secondary SPA which provided them with a disproportionate share of the proceeds. This was done by carving out £107m of the £663m equity proceeds from the corporate shareholders and reallocating to the Shareholders in return for them accepting forward-looking warranties which did not apply to the other shareholders.²

Under the terms of the SPA, the Shareholders sold their shares for £2,850 per share, Prism and Bond sold their bundles of shares for £1,555 and £1,539 per share respectively, whilst the five other shareholders received £2,134 per share.

It was flagged by various advisors at the time of the transaction that the differential pricing carried a risk of challenge that the Shareholders were selling their shares for more than UK tax market value ("MV") and therefore that PAYE and NIC could be argued to be due on the excess value.

However, the Shareholders were able to convince the Company's tax advisor to provide an opinion that the amounts received by the Shareholders represented no more than MV and therefore that the best estimate of PAYE in relation to this disposal was nil.

In February 2021, HMRC issued a determination to the Company on the basis that the excess proceeds received by the Shareholders (i.e., over and above their entitlement per the share rights set out in the Articles) constituted employment income on which PAYE should have been applied under Chapter 3D of Part 7 to ITEPA 2003, along with Class 1 NICs.³

The Company appealed the determination with several arguments.⁴ Among these, from a valuation perspective, were the following:

1. As the price paid on the disposal of the Shareholders' shares was agreed as part of an arms' length negotiation with a third-party purchaser, it meets the definition of MV for Chapter 3D purposes, thus no overvalue was received.
2. Because the Company had received advice from a well-respected accountancy firm to support the view that the amounts received by the Shareholders represented no more than MV, the Company had not been 'careless' and therefore HMRC's determination in February 2021 was issued too late for the 2014/15 tax year.⁵
3. For the same reason as argument 2, that the Company had discharged its obligation to perform a 'best estimate' for PAYE purposes, which would transfer the primary liability to account for income tax to the employee (i.e., via self-assessment instead of PAYE) and remove any liability for NICs.

The Decision

Critically from a tax valuation perspective, the tribunal looked past the fact that the transaction in totale was negotiated at arms' length between the sellers and an unconnected third-party buyer.

Instead, the focus was on whether the amounts received by each of the Shareholders reflected the MV of their shares, based on the share rights which would apply in the hands of any hypothetical shareholder, rather than only to specific individuals or to a sub-set of shareholders (e.g., employee shareholders).

The tribunal decided that, whilst the aggregate proceeds payable by the buyer did represent the MV of the total equity, the allocation of these proceeds between the shareholders was not a consideration of the buyer.

Therefore, there was no market testing of the MV of the shares being sold by each shareholder and the 'arms' length' argument could not be relied upon by the Company as evidence of MV for the purposes of assessing any liability PAYE and NIC. As such, the Company had to show that the negotiations between the sellers could prove that the allocation of value between the sellers to be treated as MV.

For various reasons, it was shown that the overallocation of value from the corporate investors to the Shareholders did not meet the definition of MV per the legislation; the best evidence of market value was the buyer's overall price for the company, not the sellers' private redistribution of that price among themselves.

Further, the tribunal found the valuation opinion received by the Company to be insufficient to provide a best estimate for PAYE purposes or to avoid the Company being adjudged as careless. This was largely due to the quality and completeness of the information provided to the advisor, but also the caveats within the valuation opinion which were not questioned or corrected by the Company.

On this basis, with the exception of 24% of the Shareholder's shares, which were found not to be ERS, the tribunal decided in HMRC's favour that the Company should have accounted for PAYE and NIC on the excess proceeds received by the Shareholders.

The Touchstone Take

The tribunal's decision highlights some interesting points relating to tax valuation that those considering the tax treatment on a disposal of ERS should consider:

1. The requirement for each specific ERS transaction within a wider deal to be negotiated at arms' length, as opposed to merely the overall transaction price, is not always considered.

   This is relevant where there are multiple acquisitions or disposals within a wider arms' length transaction.

   The most common scenarios where we see this arise in practice are:

   • Where there are reallocations between selling shareholders at the point of sale (e.g., in CooperVision)
   • Where personal or alternative rights (which would not apply to a hypothetical shareholder) are set out in the Articles of Association or any another document, such as a shareholders' agreement (e.g. in Grays Timber)
   • Where employees or directors sell ordinary shares to an investor in a secondary transaction at the same price as that investor is subscribing for preferential shares as part of the primary investment

2. The definition of market value for Chapter 3D purposes derives from ss.272-273 of TCGA 1992 which sets out the 'hypothetical transactors' concept.

   s.272 includes the need to assume that "…there is available to any prospective purchaser of the asset in question all the information which a prudent prospective purchaser of the asset might reasonably require if he were proposing to purchase it from a willing vendor by private treaty and at arm's length".

   In CooperVision, it was the word "willing" which came under the spotlight as Prism, for example, were eager to sell their shares, but the main Shareholder was described by the tribunal as being a reluctant seller, which undermined his disposal as falling squarely within the TCGA definition of MV.

   It should be remembered that there is a surprising amount of detail within the fairly brief legislation in this regard, and that the defensibility of an argument can turn on a single word.

3. A view we commonly hear is that obtaining an external valuation opinion is, in itself, sufficient to allow an employer to meet the threshold to have performed a best estimate for PAYE purposes and/or to avoid a taxpayer being labelled as 'careless' in order to reduce HMRC's determination window from six to four tax years.

   However, it should be clear from this case that it is the quality of the advice, and the accuracy and completeness of the information provided to the valuer, rather than the size or reputation of the advisor, which is critical in supporting such an argument.

Illustration

Summary of shareholdings

Summary of shareholdings
	Ords	A Ords	Prefs	Total	Ownership
Corporate investors
Prism	10,536	86,557		97,093	32.8%
Bond			31,943	31,943	10.8%
The Shareholders
John Maynard	15,790			15,790	5.3%
Bridget Maynard	15,789			15,789	5.3%
Alan Wells	118,422			118,422	40.0%
Other management
Other management	17,093			17,093	5.8%
Total	177,630	86,557	31,943	296,130	100.0%

Estimate of excess proceeds

Estimate of excess proceeds
Company equity value	£663,223,884
Total number of shares	296,130
MV per share (pro rata)	£2,240
Shares owned by the Shareholders	150,001
MV per share	£2,240
MV of Shareholders' shares	£335,947,880
Actual proceeds per share	£2,850
Aggregate sale proceeds	£427,576,350
'Excess' proceeds	£91,628,470
Of which related to ERS	76.0%
Estimated employment income	£69,637,173