NCL Investments Ltd and Another
| Jurisdiction | UK Non-devolved |
| Judgment Date | 14 June 2017 |
| Neutral Citation | [2017] UKFTT 495 (TC) |
| Date | 14 June 2017 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Jonathan Richards
Jolyon Maugham QC, instructed by the Appellants, appeared for the appellants
Julian Ghosh QC and Jonathan Bremner, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the respondents
Corporation tax – Grant of share options to employees by an employee benefit trust – Whether accounting debit arising under International Financial Reporting Standards (“IFRS”), IFRS2 deductible as a trading expense of the employing companies – Yes – Whether that debit was capital in nature – No – Whether Corporation Tax Act 2009 (“CTA 2009”), s. 1038 or s. 1290 prevents a deduction from being available – No – Decision in principle accordingly.
The First-tier Tribunal held that a corporation tax deduction was due for an accounting debit arising under IFRS2 (Share Based Payments) in relation to the grant of employee share options.
The Appellants, members of a group of companies whose ultimate parent was Smith & Williamson Holdings Limited (SWHL), employed staff pursuant to contracts of employment and made those staff available to other companies in the group in return for a fee. The group operated a number of share option schemes for the benefit of employees as follows:
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1) SWHL established an employee benefit trust (the EBT). The purpose of the EBT was to facilitate the holding of shares in SWHL by, or for the benefit of, employees of members of the group. SWHL constituted the trust by paying the initial sum of £100 to the EBT Trustee. SWHL made further payments to the EBT Trustee from time to time and the EBT Trustee used some or all of these payments to purchase, or subscribe for, shares in SWHL.
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2) The EBT Trustee held the trust fund on trust for a class of beneficiaries that included employees or former employees of any member of the Group and the Trustees had a broad power of appointment, entitling them to apply capital and income of the trust for the benefit of such beneficiaries as they should select.
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3) The EBT Trustee had the power to grant options or awards over shares in SWHL pursuant to the rules of any share scheme established by any member of the Group.
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4) From time to time, SWHL, by resolution of its board would establish a Share Scheme which set out a framework for the grant of share options to employees of the Group.
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5) When a decision was made to grant a share option to particular employees, that option was granted by the EBT Trustee. This meant that an employee's contractual rights in relation to that option were against the EBT Trustee, rather than against SWHL.
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6) Options that the EBT Trustee granted entitled the holder (subject to vesting conditions) to acquire a certain number of shares in SWHL for a specified exercise price.
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7) For accounting purposes, the Appellants recognised a periodic debit in their income statements calculated in accordance with IFRS2 (the IFRS2 debits). An equal and opposite credit was recognised as a capital contribution, reflecting the fact that, by issuing share options to employees of a subsidiary, the parent company was providing a benefit to its subsidiary and was in substance making an investment in its subsidiary.
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8) Whenever the EBT Trustee granted employees of the Appellants a share option, the Appellants agreed to pay SWHL an amount equal to the fair value of the options granted to their respective employees. This recharge arrangement was reflected in an inter-company balance owed by the Appellants to SWHL.
The Appellants, claimed deductions against trading profits corresponding to the IFRS2 debits that appeared in their income statements. HMRC raised four arguments as to why those amounts are not deductible as follows:
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1) that the expenses in question were not incurred wholly and exclusively for the purposes of the Appellants' trades with the result that CTA 2009, s. 54 prevents the expenses from being deductible;
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2) in the alternative, that the expenses were capital in nature and thus not deductible under CTA 2009, s. 53;
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3) in the alternative, that the exclusion of other deductions provision (CTA 2009, s. 1038) within the relief for employee share acquisitions rules (of CTA 2009, Pt. 12) prevents a deduction; and
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4) in the alternative, that the employee benefit contributions rules (in CTA 2009, s. 1290) prevents a deduction.
On the wholly and exclusively point, the First-tier Tribunal (FTT) found that the IFRS2 debit was properly brought into account in calculating the Appellant's accounting profits, rejecting HMRC's argument that it was not actually an expense, or that it was not actually brought into account in calculating profits. The FTT held that the expense was incurred for the purposes CTA 2009, s. 48, and that CTA 2009, s. 54 does not impose a separate free-standing requirement that the IFRS2 debit must satisfy in order to be regarded as incurred. The IFRS2 debit arose only because share options were granted to the Appellant's employees. It has a direct link to the earning of revenue profits and there was no other ulterior motive for the option grants. The recharge arrangement demonstrated that the Appellants thought they were obtaining a benefit from the option grants sufficient to warrant them paying an amount equal to the fair value of those options to SWHL. Also, the IFRS2 debit, as an accounting matter, is intended to represent a measure of the value of employees' services. For all these reasons, the IFRS2 debit was incurred wholly and exclusively for the purposes of the Appellant's trades.
On whether the IFRS2 debit was capital in nature because it was a “contra” item to the capital contribution that the Appellants were treated as receiving for accounting purposes, the FTT rejected HMRC's argument. The IFRS2 debit and the capital contribution arose only because the the EBT granted share options to employees. It is the nature of the IFRS2 debit itself that is relevant, and the nature of particular expenditure cannot be conclusively determined by an analysis of a contra item in the accounts of a different legal entity. The IFRS2 debits were not capital in nature. They arose because the employees' were remunerated with share options and the remuneration of employees has a revenue, not a capital, nature. They were recurring costs that had a connection with the Appellants' earning of income and, for accounting purposes, reflected the consumption of employees' services by the Appellants.
On the CTA 2009, s. 1038 argument, that section provides that the taxpayer is denied relief as a general trading deduction if relief is available under relief for employee share acquisitions rules (of CTA 2009, Pt. 12). The taxpayer argued that, as Pt. 12 only confers relief when shares are awarded, and not in relation to the grant of share options, it could not therefore be said that relief was available under Pt. 12, at least not until shares are ultimately awarded. If relief is however available under Pt. 12 (because shares are in fact ultimately awarded on the exercise of an option), CTA 2009, s. 1039 would only restrict relief for expenses directly related to the provision of shares. In this regard, the FTT held that the IFRS2 debits were not directly related to the provision of shares because they relate to the grant of options not the award of shares. This conclusion was supported by the accounting treatment under IFRS2 which treats the IFRS2 debit as a measure the consumption of employees' services and because the measure of value takes into account a number of factors, not all related to the SWHL shares e.g. market interest rates and the duration of the option.
Finally, the FTT held that the employee benefit contributions rules (in CTA 2009, s. 1290) did not apply because they only apply to deny or postpone a deduction in respect of employee benefit contributions and, on the facts, the arrangements did not amount to an employee benefit contribution as statutorily defined. To amount to an employee benefit contribution it would have been necessary for HMRC to demonstrate that, as a result of the grant of the share options, (i) property is held, or may be used, under an “employee benefit scheme” or (ii) there is an increase in the total value of property that is so held or may be used […]. This was not so because the share options simply embodied a set of contractual rights that entitled employees to acquire shares from the EBT for a specified price. Whilst granted in the context of a share scheme, the options could not be said to be held under an employee benefit scheme in much the same way that a payment of salary was not held under a employee benefit scheme after it had been paid. Looking at the same test from the perspective of the EBT, whilst the EBT was certainly an employee benefit scheme, the fact that the EBT Trustee needed to obtain shares to meet its contractual obligations did not mean that shares were held under the employee benefit scheme in the required sense. Those shares were not acquired to confer a separate benefit on employees but rather to enable the EBT Trustee to honour contractual obligations already provided in the form of the options. Also, on the facts, the EBT Trustee did not always acquire shares when options were granted in recognition of the fact that some options might lapse or might be valueless.
It followed that corporation tax relief was due for the amounts of the IFRS2 debits recognised in the Appellants' income statements.
This is an interesting case from a number of different angles. It not only overturns the generally accepted view that an IFRS2 debit arising in respect of the grant of employee share options is always disallowable for corporation tax purposes, but also provides clarification on the meaning of expense for the purposes of the wholly and exclusively test in CTA 2009, s. 54. In particular, it rejects HMRC's position that the IFRS2 debits had not been incurred...
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The Commissioners for HM Revenue and Customs v NCL Investments Ltd
...schemes 3 The following account of the facts is taken largely from the judgment of the First-tier Tribunal (Judge Jonathan Richards): [2017] UKFTT 495 (TC); [2018] SFTD 92. That judgment is exemplary in the clarity and cogency of its reasoning and we have found it very helpful in understan......