NCL Investments Ltd and another v Revenue and Customs Commissioners
| Jurisdiction | England & Wales |
| Neutral Citation | [2020] EWCA Civ 663 |
| Year | 2020 |
| Court | Court of Appeal (Civil Division) |
[2020] EWCA Civ 663
Lord Justice Patten, Lord Justice David Richards and Lord Justice Moylan
Court of Appeal (Civil Division)
Corporation tax – Grant of share options to employees by an employee benefit trust – Whether accounting debit arising under IFRS 2 deductible as a trading expense of the employing companies – Yes – Whether that debit was capital in nature – No – Whether CTA 2009, s. 1290 prevents a deduction – No.
The Court of Appeal upheld the decision of the Upper Tribunal, finding that debits required by IFRS 2 were deductible in calculating the companies' trading profits.
NCL Investments Ltd and Smith & Williamson Corporate Services Ltd (the taxpayers) were wholly-owned subsidiaries of Smith & Williamson Holdings Ltd (the holding company). The taxpayers carried on a trade of employing staff and making those members of staff available to other group companies.
The holding company had established an employee benefit trust (EBT). The EBT granted options to acquire shares in the holding company to the taxpayers' employees. International Reporting Standard 2 (IFRS 2) required the taxpayers to recognise a debit in their accounts on the grant of the options. The debit was unconnected with any outflow of funds from the taxpayers. The taxpayers had appealed to the First-tier Tribunal (Smith & Williamson Corporate Services Ltd; NCL Investments Ltd [2017] TC 05949) against closure noticed issued by HMRC which disallowed deductions for the debits in calculating the taxpayers' trading profits. The First-tier Tribunal found in favour of the taxpayers. The decision of the First-tier Tribunal was upheld by the Upper Tribunal (R & C Commrs v NCL Investments Ltd; Smith & Williamson Corporate Services Ltd [2019] BTC 513).
There were four issues before the Court of Appeal:
- The incurred issue: Were the debits expenses for the purposes of CTA 2009, s. 48(1) and if so, were they incurred within the meaning of s. 54(1)(a)? The Court of Appeal rejected HMRC's appeal on this point, finding that it was sufficient that the debit was required by IFRS 2.
- The purpose issue: Were the debits wholly and exclusively for the purposes of the taxpayers' trades as required by s. 54(1)(a)? The Court of Appeal rejected HMRC's argument that, as the debits did not reflect any outflows for the taxpayers, they could not be characterised as being for the purposes of their trades.
- The capital issue: Were the debits items of a capital nature with the result that a deduction was denied by s. 53(1)? HMRC were unsuccessful in their argument that, as the corresponding credit in the balance sheet represented a capital contribution for the holding company, the debit was on capital account. The Court of Appeal upheld the judgment of the Upper Tribunal that it was necessary to look at the nature of the transactions and that these were clearly revenue transactions.
- The timing issue: Did s. 1290 apply to deny or defer a deduction for the debits? This issue turned on whether, as argued by HMRC, the grant of share options amounted to an employee benefit contribution within the meaning of sections 1290 and 1291. The Court of Appeal rejected HMRC's argument, upholding the decision of the Upper Tribunal.
The Court of Appeal dismissed HMRC's appeal.
Although the requirement to recognise the debit in the company's accounts may have been “counter-intuitive”, the debit was deductible for tax purposes.
It should be noted that, as a result of changes made to CTA 2009, s. 1038, and the introduction of and 1038A by Finance Act 2013, a trading deduction would now be disallowed in similar circumstances.
Julian Ghosh QC and Jonathan Bremner QC (instructed by the General Counsel and Solicitor to HM Revenue and Customs) appeared for the appellants
Jolyon Maugham QC (instructed on a Direct Access basis) appeared for the respondents
[1] The issue on this appeal is whether debits to the profit and loss accounts of the taxpayer companies, required by generally accepted accounting practice and resulting from the grant to their employees by the trustees of an employee benefit scheme of options to acquire shares in the holding company of the group, are allowable as deductions in the computation of their profits for the purposes of corporation tax. The First-tier Tribunal (Judge Jonathan Richards) (the FTT) allowed the respondents' appeals against closure notices which disallowed the deductions. The Upper Tribunal (Mann J and Judge Timothy Herrington) dismissed the appeal of the Revenue and Customs Commissioners (HMRC), who appeal to this court with permission granted by Lewison LJ.
[2] The respondents (the taxpayers) are wholly-owned subsidiaries of Smith & Williamson Holdings Limited (the holding company). The taxpayers employ staff who are made available to other group companies in return for a fee, based on the costs incurred in employing the staff with an appropriate mark-up. It is accepted that this constitutes a trade carried on by each of the taxpayers.
[3] In 2003, the holding company established an employee benefit trust (EBT) which, in the years ended 30 April 2010, 2011 and 2012, granted options to staff employed by the taxpayers. The options entitled the grantees to acquire shares in the holding company from the EBT. There were a significant number of options which were never exercised, and therefore lapsed, either because the vesting conditions were not satisfied or because the options were out of the money at the exercise dates. Whether or not the options were in due course exercised had no impact on the deductions claimed by the taxpayers.
[4] The options represented purely contractual rights as against the trustee of the EBT and did not purport to give their holders any proprietary rights over shares. While the trustee normally held some shares in the holding company to satisfy options, it did not always have sufficient shares to do so and it would acquire shares as and when necessary to ensure that it could satisfy options that were exercised. The holding company made payments to the EBT from time to time to enable the trustee to purchase or subscribe for shares in the holding company.
[5] When options were granted to employees of one of the taxpayers, it would recognise an indebtedness to the holding company equal to the fair value of the options, which was settled monthly (the Recharge). The taxpayers passed the cost of the Recharge to the group companies using the services of their employees as part of the charge made to those companies. The options were regarded as part of the remuneration of those employees. There was no suggestion of any tax avoidance or tax mitigation scheme.
[6] The issues principally concern the construction and application of sections 46, 48 and 54 of the Corporation Tax Act 2009 (the 2009 Act). These issues have been designated as the “incurred” issue, the “purpose” issue and the “capital” issue. A further issue arises under section 1290 of the 2009 Act.
[7] The accounting treatment by the taxpayers of the grant of the options is central to the issues, other than the issue under section 1290. The FTT heard expert evidence called by the taxpayers and by HMRC and made findings that have not been challenged.
[8] The holding company and its subsidiaries prepared their statutory accounts in accordance with international accounting standards, as permitted by section 395(1) of the Companies Act 2006. Such standards comprise International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board and form part of generally accepted accounting practice (GAAP). It was common ground that the accounts complied with all applicable standards.
[9] It was also common ground that the applicable standard in relation to the grant of the options was IFRS 2, entitled Share-based Payment.
[10] Before summarising the effect of IFRS 2 in this case, as found by the FTT, it should first be noted (and this is common ground) that the fact of the Recharge is irrelevant to the accounting treatment, particularly as regards the debit in the computation of the taxpayers' profits. Indeed, the expert evidence was that it would be contrary to IFRS 2 to recognise a debit for the Recharge. As will be seen, IFRS 2 required the taxpayers to recognise a debit unconnected with the Recharge and irrespective of any recharge or other outflow of funds from the taxpayers. There is something counter-intuitive about requiring a debit to profit and loss account even though there is no outflow of funds but prohibiting a debit that does recognise an outflow of funds. This is not the first occasion on which GAAP has produced what may to the non-expert appear surprising results (see, for example, The Union Castle Mail Steamship Company Ltd v R & C Commrs [2020] BTC 10 (Union Castle)) but accounting standards are the product of careful expert evaluation and wide consultation and it is not for this court to question whether a standard is appropriate.
[11] Ironically, it is HMRC that seek to take advantage of this paradox, by submitting that the debit required by IFRS 2 does not constitute a deductible expense, and at the same time relying on IFRS 2 for the irrelevance of the Recharge.
[12] Paragraph 7 of IFRS 2 provides:
An entity shall recognise the goods or services received in a share-based payment transaction when it obtains the goods or as the services are received. The entity shall recognise a corresponding increase in equity if the goods or services were received in an equity-settled share-based payment transaction, or a liability if the goods or services were acquired in a cash-settled share-based payment transaction.
When the goods or services received or acquired in a share-based payment transaction do not qualify for recognition as assets, they shall be recognised as expenses.
[13] The options...
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