Charman v R & C Commissioners
| Jurisdiction | UK Non-devolved |
| Judgment Date | 27 August 2020 |
| Neutral Citation | [2020] UKUT 253 (TCC) |
| Date | 27 August 2020 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
[2020] UKUT 253 (TCC)
Upper Tribunal Tax and Chancery Chamber
Mrs Justice Falk, Judge Thomas Scott
Nicola Shaw QC and Michael Jones, instructed by Withers LLP, appeared for Mr Charman
Akash Nawbatt QC and Sebastian Purnell, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for HMRC
Income tax – Whether a right to acquire securities arose at time when share option was granted or only when it vested – Held when granted – Whether shares issued on share-for-share exchange were acquired as a director or employee where original shares were so acquired – Held yes.
The Upper Tribunal overturned the FTT's conclusion that options were not acquired until they vested but upheld its decision that the shares acquired in a share for share exchange were also acquired by reason of employment where the original shares had been so acquired.
In October 2001 Mr Charman was granted options over shares in Axis Specialty Ltd (Axis Specialty), a company of which he was president and chief executive), that vested in three equal annual tranches, commencing on 1 October 2002, conditional upon Mr Charman remaining in employment on the vesting date. Mr Charman ceased to be UK-resident on 21 November 2003. He exercised the options in March 2008. In September 2002, he was also awarded shares in Axis Speciality that were restricted for three years. In December 2002, as part of an initial public offering, all of the shares in Axa Speciality were exchanged for shares in Axis Capital Holdings Ltd (Axis Capital) and Mr Charman's restricted shares were exchanged for restricted shares in Axis Capital. The restrictions were lifted in 2005.
HMRC appealed against the FTT's conclusion that Mr Charman was not liable to tax in respect of the options vesting in 2004 because he was not UK-resident at that time. Mr Charman appealed against the FTT's conclusion that the restricted shares in Axis Capital were acquired as a “director or employee”.
A charge to income tax arises in respect of an employment-related option on the occurrence of a chargeable event (ITEPA 2003, s. 476). The exercise of the options in March 2008 was a chargeable event (s. 477). However, s. 474(1) excludes the charge if, when the option was acquired, the individual was not resident and ordinarily resident in that tax year. The FTT had referred to the definition of a “securities option” in s. 420(8) as a “right to acquire securities” and concluded that Mr Charman did not have a right to acquire securities until it was clear that he was still employed at the vesting date, therefore he did not acquire the third tranche of shares until they vested on 1 October 2004, at which point he was non-resident.
The Upper Tribunal (citing IR Commrs v Burton Group plc [1990] BTC 151) considered that the requirement to be employed at the vesting date was not a condition precedent to the grant of the right (although exercise was subject to a condition) and therefore the rights were a securities option at the date they were granted. This was consistent with the aim of the legislation – to impose the main tax charge on exercise not grant – if the FTT's approach was followed (that the rights were not a securities option until they vested), there would have been no exemption from charge on grant because s. 475(1) would not apply, nor would any chargeable event occurring before vesting give rise to a tax charge. They concluded that the FTT had erred in law and that a securities option had been acquired on the effective date of grant (October 2001) in relation to all three tranches.
The restricted shares were conditional shares falling within ITEPA 2003, Pt. 7, Ch. 2. The Chapter applies where a person acquires shares “by reason of [his] office or employment”. Mr Charman argued that the FTT had misdirected itself in law in determining this question, firstly by adopting an incorrect formulation of the “by reason of employment” test and secondly by incorrectly distinguishing the cases of Abbott v Philbin (HMIT) (1960) 39 TC 82 (and Wilcock (HMIT) v Eve [1994] BTC 490).
On the first ground, the Upper Tribunal did not accept that the FTT had incorrectly concluded that the shares were acquired by reason of employment simply because Mr Charman would not have acquired them if he had not been an employee. On the contrary, the FTT had identified that there might be more than one operative cause and that their task was to find the ultimate cause or source of the acquisition.
On the second ground, the Upper Tribunal considered that the FTT's first reason for distinguishing Abbott (and Wilcock) – that those cases involved options rather than shares – was overly simplistic. Nevertheless, The Upper Tribunal concluded that the question in the current appeal was not the source of the profit realised by Mr Charman (as was the case in Abbott) but instead the source of the asset (the Axis Capital shares), hence Abbott did not assist in determining the question. They found that, in approaching the question of whether the Axis Capital shares were acquired by reason of employment, the FTT had correctly taken into account all relevant facts and circumstances. These included the reason for the acquisition of the original Axis Speciality shares, the terms on which they were held and preservation of those terms in relation to Axis Capital shares, and the terms of the reorganisation. The FTT had not misdirected itself in law nor reached a perverse conclusion, and this was not affected by any errors that it might have made in reaching its conclusion.
When heard before the FTT, the principal dispute concerned the question of when the taxpayer had ceased to be UK-resident. The FTT's decision in this regard was accepted by both parties and the only questions for the Upper Tribunal to consider were the date that share-related options were acquired and whether the restricted shares were acquired as a director or employee.
[1] HMRC and Mr Charman each appeal against the decision of the First-tier Tribunal (the “FTT”) reported at [2019] TC 06899 (“the Decision”).
[2] The Decision determined a number of questions concerning Mr Charman's tax residence and his liability to UK taxation on salary, bonuses, restricted shares and share options. With permission of the FTT, HMRC appeal against the FTT's decision as to when certain share options were granted, and Mr Charman appeals against the FTT's decision as to whether certain restricted shares were acquired as a director or employee.
[3] In summary, the facts relevant to this appeal are as follows:
- Mr Charman was born in the UK. He was employed in the UK until 2001, by which time he was a senior executive in the insurance industry.
- In April 2001 Mr Charman began discussions with a US company, MMC Capital Inc (MMC), about setting up a new insurance entity in Bermuda. In late November 2001 the new entity, Axis Specialty Limited (Axis Specialty), started trading, with Mr Charman as its president and chief executive.
- Mr Charman's employment contract with Axis Specialty was dated 20 November 2001. A Share Purchase Option Agreement was appended to his employment contract, under which Mr Charman was awarded options over 253,139 Axis Specialty shares. The options were stated to vest in three equal tranches, on the first, second and third anniversaries of 20 November 2001.
- With effect from 19 September 2002, Mr Charman was awarded 50,000 restricted shares in Axis Specialty (the Axis Specialty Restricted Shares). The shares were restricted, as discussed further below, until 19 September 2005.
- As part of an initial public offering, on 31 December 2002, shares in Axis Specialty were exchanged for shares in Axis Capital Holdings Limited (Axis Capital). Under that exchange, Mr Charman and the other shareholders in Axis Specialty exchanged their shares in Axis Specialty for shares in Axis Capital. The shares received by Mr Charman were restricted (the Axis Capital Restricted Shares). Following the exchange Mr Charman's shares in Axis Specialty were cancelled.
- On 9 January 2003 Mr Charman signed a Notice of Stock Option Grant, stated to be effective as of 1 October 2001. Under that document, Mr Charman was awarded options over 253,139 Axis Specialty shares. The options were expressed to vest in three equal tranches on the first, second and third anniversaries of 1 October 2001. Although the options were stated to be over shares in Axis Specialty, in fact as a result of changes made to other documents in anticipation of the share-for-share exchange they were over an equivalent number of shares in Axis Capital. We discuss below the apparent duplication between the options granted in November 2001 and those granted with effect from October 2001 under the Notice of Stock Option Grant, but it was common ground that Mr Charman was not awarded options over two lots of shares.
- On 30 June 2003 there was a stock split in respect of Axis Capital shares which increased the number of Mr Charman's Restricted Shares to 400,000, and the number of shares over which his share options were exercisable to 2,025,112.
- The restrictions on Mr Charman's Axis Capital Restricted Shares were lifted on 19 September 2005, at which point they were worth about $11.5 million.
- On 19 and 20 March 2008 Mr Charman exercised some of his share options and sold the shares, realising in total approximately $53 million (and a profit of around $33 million).
- HMRC issued various closure notices and discovery assessments. Mr Charman appealed to the FTT against the notices and assessments, including on the ground that he was not resident in the UK at the relevant times.
[4] The FTT determined a number of issues. Those which are relevant to this appeal were as follows:
- Mr Charman was UK resident until 21 November 2003, and as a result was chargeable to tax on salary, expenses and bonuses received before...
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