The Commissioners for HM Revenue and Customs v NCL Investments Ltd
| Jurisdiction | England & Wales |
| Judge | Lord Hamblen,Lady Rose,Lord Reed,Lord Briggs,Lord Sales |
| Judgment Date | 23 March 2022 |
| Neutral Citation | [2022] UKSC 9 |
| Court | Supreme Court |
| Year | 2022 |
[2022] UKSC 9
Lord Reed, President
Lord Briggs
Lord Sales
Lord Hamblen
Lady Rose
Appellant
Julian Ghosh QC
Jonathan Bremner QC
Charles Bradley
(Instructed by HMRC Solicitors' Office and Legal Services)
Respondents
Jolyon Maugham QC
(Instructed by Smith and Williamson)
Heard on 25 and 26 January 2022
Lord Hamblen AND Lady Rose ( with whom Lord Reed, Lord Briggs and Lord Sales agree):
This appeal concerns the proper treatment, for corporation tax purposes, of accounting debits (“the Debits”) which arose in the accounts of the Respondent Companies (respectively, NCL Investments Ltd, “NCL”, and Smith & Williamson Corporate Services Ltd, “SWCS”, each a “Company” and together “the Companies”), as a result of the grant to the Companies' employees of options (“the Options”) to acquire shares in the ultimate holding company, Smith & Williamson Holdings Limited (“SWHL”), of the Companies' group in the accounting periods to 30 April 2010, 2011, 2012. The grants were made by the trustees of an employee benefit trust (“EBT”) of which SWHL was the settlor.
The Companies were required by International Financial Reporting Standard 2 (“IFRS2”) to recognise in their profit and loss accounts that the services of their employees, who were remunerated in part by the Options, had been consumed in generating their profits. The question that arises in this appeal is whether the consequential Debits are to be taken into account in calculating the profits of the Companies' trades for corporation tax purposes in accordance with the Corporation Tax Act 2009 (“the CTA 2009”).
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 understanding the arguments put forward by the parties and the proper construction of the relevant statutory provisions.
The Companies employ staff and make those staff available to other companies in the group in return for a fee. That fee is based on the costs that the Companies incur in employing the staff, marked up with a profit element. It is common ground that the activities that the Companies perform in order to earn that fee constitute a trade for corporation tax purposes. The group operates a number of employee share schemes to encourage the employees to hold shares in SWHL. To this end, SWHL set up the EBT with a trustee incorporated in Jersey (“the EBT Trustee”). SWHL makes payments to the EBT Trustee from time to time and the EBT Trustee uses those sums to buy or subscribe for shares in SWHL. The EBT Trustee has the power under the trust deed to grant options over shares in SWHL pursuant to the rules of any share scheme established by any member of the corporate group.
From time to time, SWHL establishes a share scheme setting out a framework for the grant of share options to employees. The framework covers matters such as which employees are eligible to be granted options. When a decision is taken to grant a share option to a particular employee, that option is granted by the EBT Trustee. An employee's contractual rights in relation to that option are therefore rights against the EBT Trustee rather than against SWHL or any other member of the group. The Options that the EBT Trustee grants entitle the holder to acquire a certain number of “A” ordinary shares in SWHL for a specified “exercise price”. Typically, there will also be vesting conditions associated with the grant of the Option so that the employee will only be entitled to exercise the Option if, for example, he or she remains employed by the group for a certain period of time or if certain performance conditions are satisfied. The FTT found that senior management within the group regarded the Options as forming part of the remuneration package available to employees and as “serving the desirable commercial objective of incentivising employees of the Group who were employed by the [Companies]”: para 15. It was noted that there was no suggestion that the Options were awarded for any ulterior or non-business purpose, nor was there any suggestion that the grant of the Options formed part of any tax avoidance or tax mitigation scheme.
The EBT Trustee acquired shares in SWHL so that it would be able to satisfy its obligations if Options were exercised. However, the FTT recorded that there was no strict correlation in terms of timing or number of shares between the volume of shares acquired by the EBT Trustee and the scale of its potential obligations under the Options. The evidence suggested that the EBT Trustee did not at all times hold sufficient shares to satisfy all the Options it had granted. But the EBT Trustee ensured that whenever a particular option was exercised, it would hold sufficient shares to satisfy its obligations under that option.
Whenever the EBT Trustee granted Options to the employees of the Companies, the Companies agreed to pay SWHL an amount equal to the fair value of the Options granted to their respective employees. That obligation was reflected in an inter-company balance owed by the Companies to SWHL. Each month, the Companies would settle the inter-company balance due. This arrangement has been referred to in the proceedings as the “Recharge”. The Companies passed the cost of the Recharge on to the other group companies with a mark-up by including it in the fee. The FTT found that the Companies' object in paying the Recharge would have been to benefit their trade by paying SWHL for the grant of the Options to incentivise the Companies' employees.
Significant numbers of Options granted to employees were never exercised either because the conditions entitling the employee to exercise them were not satisfied or because the Options were out of the money when they matured, that is, because the market value of SWHL shares was lower than the exercise price set in the Option. In the year ended 30 April 2010, for example, over 1.1m Options lapsed without being exercised.
The accounting years relevant to this appeal are the years ended 30 April 2010, 2011 and 2012. The Companies prepared accounts under the International Financial Reporting Standards promulgated by the International Accounting Standards Board. For the year ended 30 April 2010, the applicable accounting standard was IFRS2 “Share-based Payment” as supplemented by IFRIC8 “Scope of IFRS2” and IFRIC11 “Group and Treasury Share Transactions”. For the years ended 30 April 2011 and 30 April 2012, an amended version of IFRS2 had effect, incorporating the provisions of IFRIC8 and IFRIC11 which were then withdrawn. It was common ground that the group's accounts complied with all applicable accounting standards.
The introductory paras of IFRS2 note that a main feature of the standard is that it requires an entity to recognise share-based payment transactions in its financial statements. The Introduction also describes the purpose of the disclosure requirements included in the standard. They are to enable users of financial statements to understand:
(i) the nature and extent of share-based payment arrangements that existed during the period;
(ii) how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period was determined; and
(iii) the effect of share-based payment transactions on the entity's profit or loss for the period and on its financial position.
Para 7 of IFRS2 is headed “Recognition” and states:
“7 An entity shall recognise the goods or services received or acquired 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.
8 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.
9 Typically, an expense arises from the consumption of goods or services. For example, services are typically consumed immediately, in which case an expense is recognised as the counterparty renders service.”
As the FTT found, it follows from this that any grant of Options by the EBT Trustee to the Companies' employees triggered an obligation on the Companies to recognise an expense in their income statements equal to the fair value of the Options that the EBT Trustee had granted. This amount would not necessarily be recognised immediately but could be spread over a number of accounting periods. The obligation to recognise the expense arose whether or not the Companies had to pay any amount, such as the Recharge, to SWHL or the EBT Trustee, in relation to the grant of the Options.
The FTT noted that the required accounting treatment as set out in IFRS2 had caused some controversy at the time when IFRS2 was being proposed because some within the profession thought that the grant of share options to employees did not involve the incurring of any expense. As set out in IFRS2 Basis of Conclusions, this controversy was recognised and resolved as follows:
“‘ There is no cost to the entity, therefore there is no expense’
BC40 Some argue that because share-based payments do not require the entity to sacrifice cash or other assets, there is no cost to the entity, and therefore...
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