J E Chilcott(1)R I Griffiths (2)Evolution Group Services Ltd(3) v Her Majesty's Revenue & Customs, SPC 00727

Spc00727

Income tax – notional gains on share options – employer reimbursed by employees over 30 days after event – whether tax charge on employees under s 144A ICTA 1988 properly due – yes – appeal dismissed – whether in practice mitigation of charge possible

JE CHILCOTT (1); RI GRIFFITHS (2);

EVOLUTION GROUP SERVICES LTD (3) Appellants

- and -

Special Commissioner: JOHN CLARK

Sitting in public in London on 22 October 2008

Paul Yerbury of Fasken Martineau Solicitors, for the Appellant

Colin Williams of HM Revenue and Customs Appeal Unit, Wales Scotland and Northern Ireland, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1. This appeal concerns the application of a statutory provision in respect of events occurring in the tax year 2001-02. The provision in question is s 144A Income and Corporation Taxes Act 1998 (“ICTA 1988”), which has been replaced in similar terms for the year 2003-04 onwards by s 222 Income Tax (Earnings and Pensions Act) 2003 (“ITEPA 2003”), but with an amendment by the Finance Act 2003 for payments treated as made after 8 April 2003. (Except where stated, all statutory references in this decision are to ICTA 1988.)

2. Section 144A(1) is as follows:

“144A Payments etc received free of tax

(1) In any case where—

(a) an employer is treated, by virtue of any of sections 203B to 203I, as having made a payment of income of an employee which is assessable to income tax under Schedule E,

(b) the employer is required, by virtue of section 203J(3), to account for an amount of income tax (“the due amount”) in respect of that payment, and

(c) the employee does not, before the end of the period of thirty days from the date on which the employer is treated as making that payment, make good the due amount to the employer,

the due amount shall be treated as income of the employee which arises on the date mentioned in paragraph (c) above and is assessable to income tax under Schedule E.”

3. Section 203J provides:

“203J s 203B to s 203I: accounting for tax

(1) Where an employer makes a notional payment of assessable income of an employee, the obligation to deduct income tax shall have effect as an obligation on the employer to deduct income tax at such time as may be prescribed by PAYE regulations from any payment or payments he actually makes of, or on account of, such income of that employee.

(2) For the purposes of this section—

(a) a notional payment is a payment treated as made by virtue of any of sections 203B, 203C and 203F to 203I, other than a payment whose amount is determined in accordance with section 203B(3)(a) or 203C(3)(a); and

(b) any reference to an employer includes a reference to a person who is treated as making a payment by virtue of section 203C(2).

(3) Where, by reason of an insufficiency of payments actually made, the employer is unable to deduct the amount (or the full amount) of the income tax as required by virtue of subsection (1) above, the obligation to deduct income tax shall have effect as an obligation on the employer to account to the Board at such time as may be prescribed by PAYE regulations for an amount of income tax equal to the amount of income tax he is required, but is unable, to deduct.

(4) . . . .

(5) Any amount which an employer deducts or for which he accounts as mentioned in subsections (1) and (3) above shall be treated as an amount paid by the employee in question in respect of his liability to income tax for such year of assessment as may be specified in PAYE regulations.”

4. The evidence consisted of an agreed Statement of Facts, together with copies of correspondence and returns. I set out the Statement of Facts (with minor editorial changes), and refer later to any other matters covered in the correspondence.

STATEMENT OF FACTS

1. Evolution Capital Limited (“Evolution”) was a private limited company registered in England and Wales with registration number 3930783. It was incorporated on 22 February 2000.

2. On 23 February Mr James E Chilcott (“JEC”) was appointed director and secretary and Mr Richard I Griffiths (“RIG”) was appointed director. Each of these directors subscribed for 5 20p shares as at that date having sub-divided the normal 2 £1 subscriber shares into 10 20p shares.

3. On 27 April 2000, 2,495 shares were issued to JEC, 2,495 to RIG and 2,500 to a new shareholder, Dunedin Limited.

4. Also on 27 April 2000 4,000 options were granted to each of JEC, RIG and a third party in the proportions respectively of 1,333 to JEC, 1,334 to RIG and 1,333 to a third party.

5. Also on 27 April 2000 an Unapproved Executive Share Option Scheme was entered into.

6. On 27 April 2000 the shareholdings and options of Evolution were as follows:
   
   No. of 20p sharesNo of Options
   JEC 2,500 1,333
   RIG 2,500 1,334
   Third party - 1,333
   Dunedin Limited 2,500 -
   Totals 7,5004,000
   
   Further capital was subscribed for by unconnected third parties in May 2000 and later.

7. Evolution’s business commenced in August 2000. Its business was carrying out financial research and providing corporate finance advice to corporate and individual clients. Its particular expertise was in high-tech, bio-technology and computer technology companies. It also took equity in unquoted client companies.

8. On 1 March 2001 the entire issued share capital and options in Evolution were exchanged for shares and options in The Evolution Group PLC (“EG”) (then called EVC Christows PLC). The options were exchanged under an Option Rollover Agreement. The new options obtained were 1,428,767 shares and 1,429,839 shares for RIG and JEC respectively at exercise prices of 1p per share.

9. RIG exercised his options, now over EG shares, in June 2001 and JEC exercised his options, now also over EG shares, in December 2001. EG did not deduct any PAYE, employer’s or employee’s national insurance on the issue of new shares in EG in 2001, on the grounds that they believed the options obtained by RIG and JEC were not obtained by reason of employment.

10. The issue of whether the options were obtained by virtue of being founder shareholders or as a consequence of employment was extensively discussed between solicitors Stringer Saul and Mr JA Clark of HMRC in 2003 and early 2003.

11. On 7 December 2001 JEC exercised his options to realise a gain of £1,092,439.

12. On 7 June 2001 RIG exercised his options to realise a gain of £976,919.44.

13. RIG submitted a Self Assessment Return, dated 17 January 2003, for the period ended 5 April 2002. The taxable income received from the realisation of the share options was not declared within this return.

14. On 17 April 2003 a Self Assessment Return for the period ended 5 April 2002 was received from JEC. The taxable income received from the realisation of the share options was declared within this return.

15. On 9 May 2003 a letter was forwarded to HMRC by Stellar Financial Partners Ltd, the agents who were then acting on behalf of RIG, asking for the Self Assessment Return to be amended to include the taxable income received from the realisation of the share options.

16. On 23 October 2003 a letter was forwarded to HM Revenue & Customs by EG confirming that the company accepted liability for the Employer’s and Employees’ Class 1 National Insurance contributions arising from RIG and JEC exercising their share options in 2001. A cheque for £246,135 in settlement of this liability which should have accompanied this letter was sent with SC’s...