Valuation is important for a variety of tax purposes: capital gains tax, inheritance tax and stamp duty as well as the income tax rules for employee share transactions.
This article was first published in the November 2010 edition of Accounting and Business magazine.
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The rules can be traced back to the Finance Act 1894, which introduced estate duty (replaced first by capital transfer tax, it is now inheritance tax). A rich body of case law has accordingly been built up around the subject.
Capital gains tax
Valuation is important for capital gains tax, mainly where assets have been given away or sold at an undervalue. Section 272 of the Taxation of Chargeable Gains Act (TCGA) 1992 defines market value as ‘the price which those assets might reasonably be expected to fetch on a sale in the open market.
In estimating the market value of any assets no reduction shall be made in the estimate on account of the estimate being made on the assumption that the whole of the assets is to be placed on the market at one and the same time.'
The Act also goes on to explain which prices are to be used where the shares are quoted on an open market.
Section 273 deals with the more difficult situation where the subject of the asset valuation is a holding of shares that are not quoted on a market. Such valuations have been the trigger for many cases.
In three cases that were heard together, members of the same family disposed of shares in an unquoted Cayman Islands company which was the holding company of a trading group producing and selling sherry.
The company's articles of association had a pre-emption clause, restricting the transfer of shares to anyone who was not a member of the two families that had originally formed the company. The valuation of the shares at 31 March 1982 was disputed. The sale had been to members of the other founding family.
The special commissioners held that it was not appropriate to value the shares on an earnings basis or a dividend basis but on an assets basis and on a turnover basis to arrive at a notional quoted value which could be uplifted by a control premium of 30%, valuing the company at £46m [Hawkings-Byass v Sassen (and related appeals) SpC 1996].
Section 19 TCGA 1992 applies where assets are disposed of in a series of transactions and provides that, where the transfer is between connected persons (as defined for income tax purposes), the total value of the aggregate transfers cannot be less than the value of a transfer of the entirety of them. This would apply to collections of assets or where small shareholdings are disposed of as part of a gradual series of disposals.
Section 24 TCGA 1992 provides that where assets are destroyed or have negligible value, they can be treated as a disposal and reacquisition at that value. The claim must be submitted within two years of the asset becoming of negligible value.
Inheritance tax introduces the concept of a ‘transfer of value', which is the amount by which a person's estate has been diminished by the transfer. It also has a concept of ‘related property', which is an anti-avoidance provision.
Section 160 of the Inheritance Tax Act 1984 contains a similar definition of market value to that found in capital gains tax legislation, but the ‘loss to the estate' concept requires two valuations: one before the transfer and one afterwards.
Inheritance tax is also like capital gains tax in that transfers between spouses are not chargeable, except that inheritance tax requires that the donee spouse (or civil partner) can receive gifts only up to the value of £55,000 before the transfer becomes a chargeable transfer.
This limit is not an annual limit, but a lifetime limit. Inheritance tax also has a concept of ‘deemed domicile': for a person who is neither domiciled nor deemed domiciled in the UK, only transfers of UK assets are chargeable.
The concept of related property means that gifts between spouses that are subsequently given by each to the same third party can be aggregated.
For example: suppose that a husband has a pair of statuettes and gives one to his wife. They then give those statuettes to their son. Separately, they are worth £5,000 each, but together the pair is worth £20,000. The related property legislation will aggregate them as a chargeable transfer of £20,000 – £10,000 from each estate.
Income tax uses valuation for a variety of purposes, the main one being employment. The Income Tax (Earnings and Pensions) Act (ITEPA) 2003 uses the term ‘market value' but does not attempt to define what that is. Therefore, if the term is used, accountants tend to use the Capital Gains
Tax Act section 272 definition
Benefits in kind have different types of valuation according to their nature. For example, a loan will be valued at its cash value and any interest on the difference between the interest charged and the ‘official rate of interest', currently 4%; cars, on the other hand, have scale charge calculations according to their emissions.
Share scheme valuation is covered by ACCA Technical Factsheet 170.
Stamp duty is a tax on instruments, dating back to the Stamp Act 1891. There have been many amendments since then, with the Stamp Duty Reserve Tax Act 1990 and Stamp Duty Land Tax Act 2003 introduced to deal with situations where transactions have been entered into in such a way as to avoid instruments subject to the tax.
As a tax on an instrument, stamp duty is usually charged on the consideration for the transaction and this is the case with Stamp Duty Land Tax. However, the Finance Act 1985 abolished stamp duty on many minor instruments and, more importantly,on gifts.
If there is consideration, then stamp duty will be payable. A common example is where a husband owns a property and transfers a joint interest into the names of himself and his wife. If the property is subject to a mortgage and the wife assumes joint liability for the mortgage, she will have given consideration for her interest and stamp duty will be payable on the instrument transferring the interest.
On the other hand, if the husband includes a covenant that he alone will remain responsible for the mortgage, then the transfer will be a gift and will not require stamping.
A more difficult situation arises where the consideration consists of unquoted shares and the transfer is of land. In this case, both the interest in the land and the shares will be valued. Where a higher-value property has been exchanged for a lower-value property plus a cash payment, stamp duty will only be paid on one.
So if a £200,000 house were exchanged for a £180,000 house and £20,000 cash paid as equality money, the amount charged on the £180,000 house would be to the £180,000 and the £20,000 would be disregarded.
Schedule 15 Stamp Duty Land Tax Act 2003 deals with partnerships and includes the same related property concept as in the other tax legislation.
Stamp duty on shares is 0.5%, but only if consideration exceeds £1,000; it is rounded up to the nearest £5.
Where the consideration is unascertainable – if it is dependent on the results in 12 months' time, for example – there will be no stamp duty liability. This may be difficult in a commercial deal, but possible in a family context.
Stamp duty is easily overlooked, but doing so could be costly.
Mary Fraser, technical adviser, ACCA