Management Incentive Plans
Management Incentive Plans
HMRC Shares and Assets Valuation Section HMRC Shares and Assets Valuation section (SAV) is a specialist area of HMRC responsible for assessing the value of unquoted shares for tax purposes. The Shares and Assets Valuation Manual provides guidance on how HMRC assesses the value of shares and assets in unquoted companies for Employment Income, Inheritance Tax and CGT purposes. Pre-transaction Clearance Pre-transaction clearance is available for tax-advantaged share incentive schemes such as EMI Plans and CSOPs. From a practical perspective and to ensure clarity on the outcome, it is essential to pre-agree the valuation with HMRC. The valuation of the awards, usually detailed in a report or letter together with the other relevant documents, should be submitted to SAV. For EMI purposes, a VAL231 form needs to be completed. It is not available for non- tax advantaged share incentive schemes. By getting the value of the share option agreed with HMRC, potential problems down the line can be avoided. This includes, but is not limited to, a tax liability arising should HMRC consider that the exercise price paid for the shares is below the market value at the time of the initial award. Getting a valuation agreed upon by HMRC will typically take 2-4 weeks from date of submission. EMI valuations will be valid for 90 days from the date of the HMRC agreement letter or until a significant event occurs. Significant events include, but are not limited to, a change in the share or loan capital of the company or an arm’s length transaction (completed or actively contemplated) involving shares of the company.
Valuation Methodology It is now well established and expected by HMRC that growth shares are valued using an exit-based methodology i.e. current value is a function of anticipated future value. Two commonly used valuation approaches for growth shares are the Expected Returns approach and an Option Pricing approach. The Expected Returns approach is a probabilistic method which considers numerous iterations of the possible exit value of the company at the time of an exit or liquidity event. For each potential exit value, the amount attributable to the growth shares is then calculated by deducting net debt, and allocating equity value through a hierarchical waterfall which factors in the hurdle allocated to the growth share. This can involve complex calculations and modelling based on different iterations of business forecasts, as well as assessment of the timing of exit and probability of different exit outcomes being achieved. Determining the allocation of sale proceeds arising upon an exit or a liquidity event often requires an analysis of the relevant paragraphs in the Articles of Association. The Option Pricing approach most commonly utilises the Black-Scholes model due to the similarity in its mechanism in that if the share price or exit value fails to hit the exercise price or hurdle, there will be no payoff on the options or growth shares. Conversely, if the share price or exit value exceeds the exercise price, any payoff increases accordingly.
Minority Discounts Awards made under a MIP will usually be that of a small minority holding where the recipient has less control and influence over the company than a majority owner. This lack of control and marketability makes the recipient’s ownership stake less valuable. To account for this, the final step in the valuation of a minority shareholding is to apply a minority discount. This requires consideration of the specific terms and circumstances of the award, and the range of generally accepted discounts to ensure that an appropriate discount is
applied (thereby avoiding an over or understatement of the value of the awards). The Shares and Assets Valuation Manual no longer prescribes discount ranges according to shareholding size and requires justification of the rationale for the selected discount on a case-by- case basis. Factors to be considered include: the size of the shareholding; the achievability of the hurdle; dividend expectations and the likely timing of exit.
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