This case concerned an appeal brought by Gray's Timber Products Limited against the decision of the Special Commissioners that there was a disposal of shares for consideration which exceeded the market value at the time of disposal. Consequently the Special Commissioners held that a portion of the consideration should be treated as income as determined by Part 2 of the Income Tax (Earnings 7 Pensions) Act 2003 by virtue of Chapter 3D of Part 7 of that Act.

Mr. G held shares in Gray's Group Limited and was employed by a wholly owned subsidiary of the group, Gray's Timber Products Limited. Mr. G was allotted 14,465 ordinary £1.00 shares which represented 5% of the issued ordinary share capital of the Group. He later acquired a further 258 shares. He entered into a ‘Subscription and Shareholders Agreement’ in 1999 which provided, amongst other things, that in the event of a change in control of 50% or more of the ordinary share capital of the Group, Mr. G could dispose of his shares under the terms laid out in the Agreement. The broad terms were that in the event of a disposal of shares after the second anniversary of the completion date, Mr. G would become entitled to an agreed enhanced payment, in addition to the return of his original investment. The payment would be disproportionately greater than the amounts received by the other shareholder or his percentage of the equity shares of the Gray's Group Limited.

On 29 November 2003, the entire share capital of the Group was sold to an unconnected third party for a total consideration of £5,903,219 of which a total of £1,451,172 was paid to Mr. G.

The issue brought to the Court of Session concerned the tax consequences of the disposal by Mr. G of his shares. The Special Commissioners contended that where employment related securities are disposed of for more than market value the excess over market value is taxed on the employee as income tax rather than capital gains. By contrast the taxpayer argued that as a matter of fact he had not received more than market value for his shares because under the agreement he was entitled to 25% of the total consideration for his shares.

The Court of Session stated that what was important about the Subscription Agreement was that it bound only the parties to it, not all shareholders. The Special Commissioners had rejected the taxpayer's argument that whether Mr. G's position was reflected in the Subscription Agreement or the Articles of Association made no difference. The Special Commissioners contended that it did make a difference as it was the shares that had to be valued and not the rights attached to them by Mr. G. The rights which Mr. G enjoyed beyond those as a shareholder were personal rights which he enjoyed exercisable against other parties to the Agreement but did not attach to his shares.

The Court of Session, in reaching its decision, re-emphasised that when valuing the shares there is deemed to be a transaction between a hypothetical seller and a hypothetical purchaser. The hypothetical seller in this case would not necessarily have had the benefit of the shareholders agreement. Mr. G's rights under the Agreement did not affect the price that a hypothetical purchaser would be prepared to pay, because they were specific and personal to him, they would not be valu able to a hypothetical purchaser of the company. In those circumstances, while certain aspects of the Special Commissioners reasoning might be unsatisfactory, he was correct in the view that the price paid represented a consideration greater than the market value of the shares.

The Court held that the consideration received by Mr. G was payment for his shares and certain personal rights which he enjoyed. It was incorrect to say that Mr. G had received market value for his shares. On these grounds, the appeal was refused.

The full text of the case is available at
http://www.bailii.org/cgi-bin/markup.cgi?doc=/scot/cases/ScotCS/2009/2009CSIH11.html&query=Grays+and+Timber+and+Products&method=boolean