Determining the “value” of shares received by an employee under a share purchase agreement
Tax Alert - May 2017
By Jayesh Dahya and Blake Hawes
Hot on the heels of the new share reporting rules, which came into force on 1 April 2017, and the recent tax bill introducing proposed changes to the taxation of employee share schemes, Inland Revenue has released a Commissioner’s Statement CS17/01 providing guidance on how to determine the value of shares received under a share purchase agreement (“SPA”).
With employers now required to report share benefits received by employees to Inland Revenue, questions have arisen on which methods are considered acceptable in valuing the benefit that is reported.
It is pleasing to see that if one of the methods outlined in the statement is adopted and documentation is retained to support the valuation, Inland Revenue will accept that valuation. Importantly, it is noted that “absolute accuracy is not expected in all scenarios”.
Value of the Share Benefit
A share benefit arises under a SPA when shares are acquired by the employee for an amount less than market value.
The value of the benefit is the difference between the market value of the shares and the amount paid or payable on the date of acquisition.
The statement notes that the Income Tax Act does not define “value” and does not prescribe methods to determine value. The value of the shares is the “market value of the shares” being the value that the shares would be exchanged for between two non-associated third parties, on an arm’s length basis.
For listed shares on a recognised exchange (under YA 1), the following methods of share valuation are acceptable:
- Volume Weighted Average Price (VWAP) which is calculated using the price of the last five trading days, inclusive of the acquisition date. The price of the share is multiplied by the number of shares traded and then this is divided by the total shares traded for the day. The VWAP calculation and listed price data needs to be retained to support the value and method; or
- Closing price of the listed share on the acquisition date. The closing market listed price data is required to support this method; or
- If the employee disposes of the shares on the date of acquisition on a recognised exchange, the actual proceeds of sale on that date.
For shares that are listed on an overseas recognised exchange, conversions to New Zealand dollars are to be undertaken using the close of trading spot exchange rate on the acquisition date.
For companies listed on several exchanges, conversions should be undertaken based on the listed price on the recognised exchange in the employee’s country of residence. If this is not applicable, the listed price will be the average of all the listed prices converted to New Zealand dollars.
In all cases, documentation is required to support the method that is used.
Newly Listed Companies
Shares issued to employees as part of an Initial Public Offering (“IPO”) are to be valued using the published offer price included in the retail offer documentation.
If the shares are only available to non-retail investors, the VWAP price of the investors should be used.
For unlisted shares (not start-up company shares), the following methods of share valuation are considered acceptable by the Commissioner.
- An arm’s length value determined by a qualified valuer that conforms with generally accepted practice; or
- A valuation based on an arm’s length transaction (e.g. capital raising) undertaken in the last six months involving the issue or sale of the same class of shares. If this method is used, the company is required to retain documentation that supports the value of the shares at the time of the arm’s length transaction and also a written statement from either a member of the Board of Directors, the Chief Executive Officer or the Chief Financial Officer of the company that the value reflects the market value of the shares at the acquisition date; or
- A valuation prepared by an appropriate person within the company. To support the share value, the company should retain the following information:
- A copy of the valuation, details of the valuation method (discounted cash flow and capitalisation of earnings methods are considered to appropriate) and all underlying workings and assumptions.
- Evidence that the person preparing the valuation has the necessary financial skills, qualifications and experience to make this valuation
- Written approval of the valuation from either a member of the Board of Directors, Chief Executive Officer or Chief Financial Officer of the company. Alternatively, approval from a suitably qualified valuer appointed by the Board of Directors will also be sufficient.
The Commissioner will accept a previous valuation to determine the value of a share provided under a SPA if the valuation relates to the same class of shares and is not more than six months old.
For a start-up company the valuation methods are broadly the same as an unlisted company except that a valuation based:
- On a recent transaction (e.g. capital raise) can be used as a proxy for market value if the transaction has occurred within the last 12 months.
- On a value determined by an appropriate person in the company will require the use of the discounted cash flow method as this is the only method considered appropriate by the Commissioner.
The Commissioner will accept a previous valuation to determine the value of a share provided under a SPA, if the valuation relates to the same class of shares and is not more than 12 months old for a start-up company. However, given the complexities associated with share valuations for venture capital funding rounds, this Statement will not apply to a company with a current or proposed (i.e. is intended to take place within six months of acquisition date of shares by employee) venture capital funding round, i.e. funding by a venture capital fund or firm (including Series A funding rounds) but not a seed funding round.
Overall it is good to see guidance from the Inland Revenue to help employers with valuing shares provided to employees under a SPA. However, one does have to question the subtle differences between start-up companies and other unlisted companies and the somewhat vague definition of a start-up. An unlisted company (not a start-up) can only use a previous valuation to determine the value of a share acquired under a SPA if it is within six months of acquisition whereas a start-up company can use a valuation that is up to twelve months old. Why not just allow twelve months for all unlisted companies? The distinction seems to be arbitrary, particularly when the values of a start-up company are likely to change far more rapidly than the value of more established companies.
If you have any questions or comments, please contact your usual Deloitte advisor.
May 2017 Tax Alert contents