R & C Commissioners v Vermilion Holdings Ltd
| Jurisdiction | UK Non-devolved |
| Judgment Date | 27 May 2020 |
| Neutral Citation | [2020] UKUT 162 (TCC) |
| Date | 27 May 2020 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
[2020] UKUT 162 (TCC)
Upper Tribunal (Tax and Chancery Chamber)
The Honourable Lord Ericht, Judge Dean
Mr Roderick MacLeod, Advocate, instructed by the Office of the Advocate General for Scotland, for the Appellant (HMRC)
Philip Simpson QC and David Pett, Barrister, instructed by French Duncan LLP for the Respondent (Vermilion Holdings Limited)
PAYE & NIC – ITEPA 2003, s. 471 – Grant of share option to director – Whether by reason of an employment – Yes – Appeal allowed.
The Upper Tribunal found in favour of HMRC, overturning an earlier FTT decision and determining that share options granted to a director were “by reason of an employment” and thus subject to both PAYE and NICs.
An individual (Mr Noble) had been granted a share option in lieu of fees in respect of his work as a self-employed adviser to the company (Vermilion). Later the company got into financial difficulty and a rescue package was agreed. The package was conditional upon Mr Noble becoming a director and executive chairman of the company and also upon either an amendment to or cancellation of the original option agreement. Mr Noble chose to cancel the existing option and in return was then granted a new option under revised terms.
The issue was whether the new option agreement was “available by reason of an employment” under s. 471 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). If it was, then PAYE and NICs would apply to the subsequent gain on exercise of the option. As the value of the underlying shares had increased by £636,238 the combined amount of PAYE and NICs at stake was £385,858.
Vermilion contended that the new option was simply a replacement of an option which had been granted at a time when Mr Noble was not a director and at that time it was not envisaged that he ever would be, therefore the new option should not be regarded as being by reason of his employment.
HMRC considered that the issue of the original option was not relevant and made two substantive arguments. Firstly, a new option had been granted at a time when Mr Noble was a director and the reason for granting it was at least partly because of his employment. Secondly, that even if the actual reason had not been because of the employment, s. 471 would deem it to have been so.
Initially, the First Tier Tribunal (FTT) had found in favour of Vermilion and HMRC appealed to the Upper Tribunal (UT).
The question of employment did not arise, as a director is an office holder and as such is treated as an employee by s. 5 ITEPA.
The case hinged on clauses (1) and (3) of s. 471 ITEPA:
471(1) This Chapter applies to a securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person.
471(2) For the purposes of subsection (1) “employment” includes a former or prospective employment.
471(3) A right or opportunity to acquire a securities option made available by a person's employer, or a person connected with a person's employer, is to be regarded for the purposes of subsection (1) as available by reason of an employment of that person unless–
- the person by whom the right or opportunity is made available is an individual, and
- the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.
HMRC's arguments were that that clause (1) was satisfied, but even if the actual reason for issuing the option was not rooted in Mr Noble's employment, the wording of clause (3) meant that it would automatically be regarded as being “ by reason of an employment” unless one of the two exemptions applied, which was plainly not the case.
There was an attempt to block HMRC's first argument by contending that it was a new point which had not been previously raised and was thus outside the scope of this appeal. However that argument was dismissed by the UT and it was shown that the original appeal documents had referred to s. 471(1).
Vermilion then argued that clause (1) of s. 471 was not satisfied because the option was granted to replace an existing option which was not employment related. Furthermore, the replacement option was under less favourable terms and so it would be absurd to treat it as a reward of employment under clause (3), given that it represented a reduction in Mr Noble's rights.
The reason Mr Noble's original option agreement could not continue was that other investors involved with the rescue package considered it to be unfair because of its favourable (non-dilution) terms. Mr Noble would be getting a “free ride”. Consequently, it was a fixed condition of the rescue funding that either the terms should be altered or that it should be cancelled and a revised option agreement issued. Mr Noble opted for cancellation rather than revision. This choice may have had a significant bearing on the subsequent tax position. Had an amendment been made, rather than a new option being granted, then a different set of arguments might have applied. However, the UT was bound to consider the circumstances as they were, not how they might have been if a different choice had been made.
Another condition of the rescue funding was that Mr Noble should be appointed executive chairman of the company.
The UT found that the because the rescue package was dependent on both of these two conditions (amongst others), the issue of the revised option agreement was at least partly by reason of Mr Noble's employment. Following the precedent of Wicks v Firth [1982] 1 CH 355, the UT decided that it was not necessary for employment to be the sole or even the dominant reason. It is sufficient that Mr Noble's employment was a condition of the new option being granted.
Consequently the UT held that clause (1) of s. 471 was met and it was therefore not necessary to go on to consider whether clause (3) would have applied.
Dismissing Vermilion's argument in respect of absurdity, the UT pointed out that although the original option was granted on more favourable terms, it had already become worthless because of Vermilion's financial difficulties. The company was going to fail without rescue funding. The new option was therefore not taking away value from Mr Noble, as there was no value to be taken.
HMRC's appeal was allowed.
This case illustrates the broad scope of s. 471 (and also of s. 421B which mirrors its wording in respect of shares issued) in determining whether shares options have been granted “by reason of an employment”. Employment need not be the only, or even the main reason for the grant – it is sufficient that employment is one of the reasons.
[1] An adviser to a company took an option over shares in the company instead of fees. The company came to be in financial difficulty. A rescue package was agreed with investors. The package was conditional on the adviser becoming director and executive chairman of the company and cancellation or amendment of the option. The adviser became director and executive Chairman and the option was cancelled and a new share option granted.
[2] The issue in this case is whether the new share option falls within the provisions of sec 471 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) to be treated as an employment-related securities (ERS) option for tax purposes.
[3] Section 471 of ITEPA provides as follows:
(1) This Chapter applies to a securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person.
(2) For the purposes of subsection (1) “employment” includes a former or prospective employment.
(3) A right or opportunity to acquire a securities option made available by a person's employer, or a person connected with a person's employer, is to be regarded for the purposes of subsection (1) as available by reason of an employment of that person unless–
- the person by whom the right or opportunity is made available is an individual, and
- the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.
…
(5) In this Chapter–
- the acquisition, in relation to an employment related securities option, means the acquisition of the employment-related securities option pursuant to the rights or opportunity available by reason of the employment.
- the employment means the employment by reason of which the right or opportunity to acquire the employment-related securities option is available (the employee and the employer being construed accordingly), and
- employment-related securities option means a securities option to which this chapter applies.
[4] The facts are set out in detail in the Decision of the First Tier Tribunal and can be summarised as follows.
[5] In 2006, an exercise to raise equity funding for Vermilion Software Limited took place. As part of that exercise Vermilion Holdings Limited (“Vermilion” or the “Taxpayer”) was set up. Vermilion was advised on the equity funding by Mr Noble and Dickson Minto WS. Mr Noble is a corporate advisory merger and acquisition and technology business specialist. He often works alongside management as a director cum investor. Dickson Minto WS is a firm of solicitors. Vermilion granted an option (the “2006 Option”) in favour of Mr Noble's nominee company Quest Advantage Limited (“Quest”). It also granted an option in favour of Dickson Minto's nominee company (the “Dickson Minto Option”). These options were effectively payment for services which were provided in the process of the fundraising exercise.
[6] However, by January 2007 Vermilion was in financial difficulty. As Mr Noble put it, Vermilion was “going to go bust.” It was apparent that a further injection of...
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