Grays Timber Products Ltd v HM Revenue and Customs

JurisdictionScotland
JudgeLORD WALKER,LORD HOPE,LORD RODGER,LORD BROWN,LORD KERR
Judgment Date03 February 2010
Neutral Citation[2010] UKSC 4
CourtSupreme Court (Scotland)
Docket NumberNo 1
Date03 February 2010
Grays Timber Products Limited
(Appellants)
and
Her Majesty's Revenue and Customs
(Respondents) (Scotland)

[2010] UKSC 4

before

Lord Hope, Deputy President

Lord Rodger

Lord Walker

Lord Brown

Lord Kerr

THE SUPREME COURT

Hilary Term

On appeal from: [2008] CSIH 11; 2009 SLT 307

Appellant

Michael Sherry

Alun James

(Instructed by Biggart Baillie LLP)

Respondent

David Johnston QC

Iain Artis

(Instructed by HM Revenue and Customs)

LORD WALKER

Introductory

1

In November 1999 Mr Alexander Gibson was appointed as managing director of Grays Timber Products Ltd ("Timber Products"), a wholly-owned subsidiary of Grays Group Ltd ("Group"). He also became a director of Group. He entered into a written service agreement with Timber Products and was also party to a subscription and shareholders' agreement ("the subscription agreement") under which he paid £50,000 to take up ordinary shares (amounting to about 6% of the issued ordinary capital) in Group. In November 2003 all the issued ordinary shares in Group were acquired by an outside purchaser, Jewson Ltd ("Jewson") for £6m, about £5.4m of which was paid in cash. Under the terms of the subscription agreement (to which Group and shareholders owning over four-fifths of its ordinary shares were parties) Mr Gibson became entitled to a disproportionately large part of the consideration paid by Jewson – just over £1.4m, whereas a rateable part would have been just under £0.4m. The issue for the Court is whether the difference between these two sums is (as HM Revenue & Customs -"HMRC" – contend) taxable as employment income of Mr Gibson, subject to income tax and national insurance contribution ("NIC"), or is (as Mr Gibson contends) taxable as a chargeable gain subject to capital gains tax. The claim for income tax and NIC is primarily against Timber Products as Mr Gibson's employer at the time, but if it succeeds the burden will fall on Mr Gibson and others who have covenanted with Jewson to bear those liabilities.

2

That issue depends primarily on the correct construction and application of Chapter 3D of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA 2003") as inserted by the Finance Act 2003, Schedule 22. Chapter 3D consists of only three sections which are, by comparison with other chapters in Part 7 of ITEPA 2003 (as amended), relatively simple and straightforward. They are as follows:

"CHAPTER 3D – Securities Disposed of for More Than Market Value

"446X Application of this Chapter

This Chapter applies if–

  • (a) employment-related securities are disposed of by an associated person so that no associated person is any longer beneficially entitled to them, and

  • (b) the disposal is for a consideration which exceeds the market value of the employment-related securities at the time of the disposal.

446Y Amount treated as income

  • (1) Where this Chapter applies the amount determined under subsection (3) counts as employment income of the employee for the relevant tax year.

  • (2) The 'relevant tax year' is the tax year in which the disposal occurs.

  • (3) The amount is –

    CD – MV – DA.

where -

CD is the amount of the consideration given on the disposal,

MV is the market value of the employment-related securities at the time of the disposal, and

DA is the amount of any expenses incurred in connection with the disposal.

446Z Definitions

  • (1) In this Chapter 'market value' has the meaning indicated in section 421(1).

  • (2) For the purposes of this Chapter sections 421(2) and 421A apply for determining the amount of the consideration given for anything.

  • (3) In this Chapter –

    'the employee', and

    'employment-related securities',

    have the meaning indicated in section 421B(8).

  • (4) In this Chapter 'associated person' has the meaning indicated in section 421C."

It is common ground that Mr Gibson's shares were "employment-related securities". He was an "associated person" and no issue arises as to any other "associated person". The main area of controversy is "market value", which is defined by reference to the Taxation of Chargeable Gains Act 1992.

3

However Chapter 3D forms part of a complex code with fairly deep and tangled legislative roots. Many of the submissions made on behalf of Timber Products (which has been the appellant at every stage in these proceedings) relied on the need for the expression "market value" to be given a uniform meaning throughout the different chapters comprised in Part 7 of ITEPA 2003. It is therefore appropriate to attempt at least an outline sketch of Chapter 3D's larger context, without going far into complexities which are not directly relevant.

4

Part 7 of ITEPA 2003 is headed "Employment income: income and exemptions relating to securities." Its provisions reflect three different, and to some extent conflicting, legislative purposes. First there is Parliament's recognition that it is good for the economy, and for social cohesion, for employees to own shares in the company for which they work. Various forms of incentive schemes are therefore encouraged by favourable tax treatment (those in force in 2003 are covered in Chapters 6 to 9 inclusive of Part 7).

5

Second, if arrangements of this sort are to act as effective long-term incentives, the benefits which they confer have to be made contingent, in one way or another, on satisfactory performance. This creates a problem because it runs counter to the general principle that employee benefits are taxable as emoluments only if they can be converted into money, but that if convertible they should be taxed when first acquired. That principle was stated by Lord Radcliffe in Abbott v Philbin [1961] AC 352, 379:

"I think that the conferring of a right of this kind as an incident of service is a profit or perquisite which is taxable as such in the year of receipt, so long as the right itself can fairly be given a monetary value, and it is no more relevant for this purpose whether the option is exercised or not in that year, than it would be if the advantage received were in the form of some tangible form of commercial property."

That was a case about share options, which are now dealt with separately in Chapter 5, but it illustrates the general approach that applied in the days when the taxation of employee benefits was very much simpler than it is now.

6

The principle of taxing an employee as soon as he received a right or opportunity which might or might not prove valuable to him, depending on future events, was an uncertain exercise which might turn out to be unfair either to the individual employee or to the public purse. At first the uncertainty was eased by extra-statutory concessions. But Parliament soon recognised that in many cases the only satisfactory solution was to wait and see, and to charge tax on some "chargeable event" (an expression which recurs throughout Part 7) either instead of, or in addition to, a charge on the employee's original acquisition of rights.

7

That inevitably led to opportunities for tax avoidance. The ingenuity of lawyers and accountants made full use of the "wait and see" principle embodied in these changes in order to find ways of avoiding or reducing the tax charge on a chargeable event, which might be the occasion on which an employee's shares became freely disposable (Chapter 2) or the occasion of the exercise of conversion rights (Chapter 3). The third legislative purpose is to eliminate opportunities for unacceptable tax avoidance. Much of the complication of the provisions in Part 7 (and especially Chapters 3A, 3B, 3C and 3D) is directed to counteracting artificial tax avoidance. There is a further layer of complication in provisions which regulate the inevitable overlaps between different chapters. It is regrettable that ITEPA 2003, which came into force on 6 April 2003 and was intended to rewrite income tax law (as affecting employment and pensions) in plain English, was almost at once overtaken by massive amendments which are in anything but plain English.

8

This case is, it seems, the first case concerned with any of the provisions of Part 7. Timber Products' appeal from a revised determination dated 3 November 2005 was dismissed by a single Special Commissioner (Mr Demack) by a written decision released on 21 March 2007. Timber Products' appeal to an Extra Division of the Inner House of the Court of Session (Lord Kingarth and Lord Mackay of Drumadoon, Lord Osborne dissenting) was dismissed on 13 February 2009. The reasoning of the majority of the Inner House was rather different from that of the Special Commissioner, and counsel for Timber Products has sought to deploy further arguments in this Court.

The subscription agreement and the sale agreement

9

The facts relevant to this appeal are set out in some detail in the decisions of the Special Commissioner and the Inner House (especially the judgment of Lord Osborne). Those decisions are readily accessible, being reported together at [2009] STC 889. I need not therefore add a lot of detail to the brief summary at the beginning of this judgment. But I must give a fuller account of the subscription agreement entered into in 1999 and the sale agreement dated 29 November 2003, especially as they affected Mr Gibson's shares in Group.

10

The subscription agreement was not dated but was signed at different dates between 2 December and 18 December 1999. The parties to it were (1) Group (2) Mr Gibson and (3) Mr J R Nicholson (who owned about 60% of the ordinary shares) and other shareholders who (together with Mr Nicholson) owned about 84% of the ordinary shares. Recital (B) provided:

"Mr Gibson wishes to subscribe up to 14,465 ordinary shares of £1 each in the share capital of [Group] and [Group] has agreed to issue such shares to him on the terms and conditions set out below."

11

Clause 3 provided for what was to happen to the shares if Mr Gibson's employment ended while he still owned them. If he was dismissed for a serious...

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