Vermilion Holdings Ltd
| Jurisdiction | UK Non-devolved |
| Judgment Date | 08 April 2019 |
| Neutral Citation | [2019] UKFTT 230 (TC) |
| Date | 08 April 2019 |
| Court | First Tier Tribunal (Tax Chamber) |
[2019] UKFTT 230 (TC)
Judge Heidi Poon
Philip Simpson QC, instructed by French Duncan LLP appeared for the appellant
Alan Waters, Officer of HM Revenue and Customs, appeared for the respondents
Income tax – PAYE and NIC – Grant of share option – Whether made available by employer – Whether thereby deemed as made available by reason of employment – Whether limitation of deeming provision by statutory construction.
The First-tier Tribunal allowed the taxpayer's appeal against income tax and NIC determinations by HMRC on the exercise of a share option: the option in question was not in fact obtained “by reason of employment” and the deeming provision to that effect should be limited so as not to apply; alternatively, such deeming provision did not apply at all because the option was not “made available” by the employer.
In 2005, W met the founders of Vermilion (“V”) and considered V an investment opportunity. W then approached Mr Noble (“N”) in relation to V. At that point in time, V was significantly under-capitalised; trading was poor. Selling to large global enterprises meant that the sales cycle was lengthy, and with significant barriers. As a small company selling to large corporate organisations, the management team lacked the expertise to grow and develop the business. It was recognised that V needed additional capital, the management team strengthened, and the sales process professionalised.
An equity raising exercise in 2006 ensued after the discussions between W and N. Due diligence into the financial and legal aspects of V was a prerequisite for the equity raising exercise, and for approaching credible investors. To that end, and through N:
- A law firm, DM, was brought in to act as legal advisers.
- QA Ltd was brought in to produce a business plan and financial projection. QA Ltd was a corporate advisory and consulting business owned by N and one other.
The exercise in 2006 raised around £2.5m. The shareholders after the exercise were considered to fall into three groups:
- Shareholder directors: the founders, together holding a controlling interest of 55% of the total equity.
- Private equity investors: 8 in total including N and DM.
- Consortium investors: 5 in total.
DM's legal work in connection with the fundraising was ultimately significantly greater than was originally anticipated at the outset. However, the incoming investors had approved the budget for the refinancing process and did not wish funds which were required for the development of V's business to be applied in meeting an overrun on legal and other advisory fees.
As a result, “Supplier Options” were granted to DM's nominee and to QA Ltd. The evidence given was that these Supplier Options “recognised that significant additional work had been done which was not being paid for by the Company at the time … [and] were effectively payment for services which had been provided in the process of the fundraising exercise, which terminated in a successful financing.”
DM and QA Ltd were each granted an option package of 2.5% each of the equity in V.
By December 2006, it became clear V was in financial difficulty, and the business was significantly under-performing. A rescue funding proposal was agreed. Most of the investors of the 2006 funding round also invested in this 2007 rescue funding exercise. But the Consortium investors as a group emerged to become the major shareholders owning 55% of the equity. A precondition of the Consortium investment was that N would be appointed as Chairman of V to drive and oversee the performance and report regularly to the investors; it was recognised that N would need to devote not less than 1–2 days a week to the business, and would receive a fee for his services. The letter setting out the terms of such appointment stated that it was a contract for services, and N would not be an employee of V.
By agreement, the 2006 Options held by DM and QA Ltd were amended (by way of cancellation of 2006 options and grant of new 2007 Options), so as to be in respect of 1.5% of the equity on an “Exit”. The contractual parties in the QA Ltd 2007 Option agreement were V and QA Ltd, the latter acting as the nominee company for N.
Pursuant to a novation agreement signed in June 2016, N was substituted in place of QA Ltd as holder of the 2007 Option, in anticipation of a sale of V which completed in November 2016. The agents for N and V then submitted a non-statutory clearance request to HMRC, seeking agreement that N's gain on exercise of the 2007 Option (in an amount of some £636,000), was liable to CGT.
HMRC responded to this request, stating that the 2006 Option was not, but the 2007 Option was, an employment-related securities option within ITEPA 2003, s. 471. Subsequently HMRC opened an Employer Compliance Enquiry into V, under the PAYE Regulations. In connection with an internal review by HMRC, V's agents sent a copy of their notes of conversations with HMRC, recording HMRC officers“” comments as: (a) “on a purposive view the ERS provisions do not seem appropriate”; and (b) that “it was probably not the intention that such situations should be caught”. HMRC responded that even if the officers did suggest that it was not the intention of the legislation, it remained a factual test, and the facts supported the conclusion that the 2007 Option was employment related.
V's appeal to the Tribunal was against a reg. 80 Determination and a s. 8 Decision, charging, respectively, PAYE income tax and NICs.
The judge said that V submitted that the legal issue was whether the 2007 Option was “made available by [N's] employer”. The argument that it was not included that:
- The 2007 Option was made available to N only because he already had the 2006 Option, and that he was willing to give up 40% of the 2006 Option.
- It was plain the reduction in the percentage of the equity in V could have been achieved in a number of different ways, including, for example, simply amending the 2006 Option Agreement by replacing 2.5% with the figure 1.5% where it appeared.
- Adopting a purposive approach to the ITEPA provisions, which was to charge to income tax the value of shares acquired on exercise of options which are a reward for the employment, the 2006 Option was not obtained by reason of employment, and this likewise applied to any value obtained from the 2006 Option, which would include the 2007 Option.
V's alternative submission was that the 2007 Option was in substance the same as the 2006 Option.
HMRC in response said the cardinal rule was to construe legislation according to the intention expressed in the language. The material fact was that N was given the right to acquire shares under the Option on 2 July 2007 when he was a director of V, and that was sufficient for the deeming provision in ITEPA s. 471(3) to apply that the grant of the 2007 Option was “by reason of” employment.
The judge said the critical issue in the appeal lay with the interpretation of the deeming provision in ITEPA, s. 471(3). As a matter of fact, N's directorship was not the causa for the grant of the 2007 Option, but for the same reason as DM being granted a 2007 Option. Without their respective Supplier Options granted in 2006, neither N nor DM would have been granted the right to the 2007 Options. The right to acquire the 2007 Option in each case emanated from the right under the 2006 option.
However, HMRC's contention was that the deeming effect of s. 471(3) meant the grant of the 2007 Option “was to be regarded” as having been made available by reason of N's directorship, despite any fact-findings to the contrary. In the judge's view, the deeming provision under s. 471(3) set up a presumption, which was to say, upon a finding of fact that “the person's employer” (or a person connected with that employer), had made available a right or opportunity to acquire a securities option, the deeming effect automatically applied. So the question was: Was a right to acquire the 2007 Option “made available” by V? The plain fact was that V was the grantor of the 2007 Option, as evidenced by the Option agreement.
An anomaly therefore arose between a statutory fiction as a result of the deeming provision under s. 471(3), and the finding of fact that the 2007 Option was not granted by reason of N's employment. In this regard, the case of Marshall (HMIT) v Kerr [1994] BTC 258 indicated that if the construction of a deeming provision would lead to injustice or absurdity, the application of the statutory fiction should be limited to the extent needed to avoid such injustice or absurdity, unless such application would clearly be within the purposes of the fiction.
In the judge's view, the ambit of the deeming provision should be limited where the artificial assumption from deeming was at variance with the factual reason that gave rise to the right to acquire the option. As stated, the 2007 Option was not made available by reason of N's “employment” (directorship) in V. In the alternative, the deeming effect of s. 471(3) could be limited by adopting V's submissions in relation to the interpretation of who (or what) had “made available” the right or opportunity for N to acquire the 2007 Option. The analysis of the underlying causes that led to the grant of the 2007 Option, and the economic mechanism whereby the 2007 Option came to be granted, when viewed realistically, meant that N's right to acquire the 2007 Option was not “made available” by V as his “employer”.
For those reasons V's appeal fell to be allowed.
This case comprised a very particular and complex set of facts indeed. Key to the decision was that the 2007 Option derived from the 2006 Option, and it was accepted by HMRC that the prior Option (the decision does not state clearly if this Option also belonged beneficially to N) was not employment-related.
Notwithstanding the bespoke nature of the facts, it is an interesting decision on the scope of the “deemed by reason of...
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Vermillion Holdings Ltd v R & C Commissioners
...had access to [the 2007 Option] because of his role as director and hence the share option is employment related. First-tier Tribunal ([2019] TC 07077) [16] The appellants appealed to the FtT. In their statement of case, the respondents again contended that the 2007 Option was a securities ......