Employment-related securities options: UK Supreme Court clarifies deeming provisions
Published on 9th Nov 2023
The Supreme Court has allowed HMRC's appeal in a long-running employee share options case
On 25 October 2023, the Supreme Court handed down the long-awaited judgment in HMRC v Vermilion Holdings Ltd, unanimously allowing HMRC's appeal.
The decision provides clarity on the deeming provisions applicable to employment-related securities and options, which bring such share awards into the scope of employment income (rather than capital gains tax) for UK tax purposes.
HMRC v Vermilion
In 2006, Vermilion Holdings Limited (Vermilion) granted an option to a corporate advisory company owned by a Mr Noble.
In 2007, the business was running out of working capital and Vermilion entered into a rescue funding package. There were a number of preconditions to the refinancing, including the appointment of Mr Noble as executive chairman of Vermilion and varying the terms of the 2006 option (which resulted in the grant of a new option by Vermilion to the corporate advisory company in 2007, in place of the 2006 option).
Some years later, the 2007 option was transferred to Mr Noble (under a novation agreement) and the 2007 option was exercised by Mr Noble.
The courts (and ultimately the Supreme Court) had to consider the circumstances in which the exercise of a securities option is brought within the charge to income tax instead of capital gains tax. Was the 2007 option an employment-related securities option under the relevant tax legislation?
Supreme Court decision
The Supreme Court held that Mr Noble was deemed to have acquired the 2007 option because of his employment and directorship. As it was an employment-related securities option, the exercise of the 2007 option was accordingly subject to income tax (and National Insurance contributions).
Delivering the judgment, Lord Hodge confirmed that the applicable legislation, the lncome Tax (Employment and Pensions) Act 2003 (ITEPA), defines the circumstances in which the exercise of a securities option is brought within the charge to income tax by two methods:
1. by a causal test (set out in section 471(1) ITEPA), asking whether the right or opportunity to acquire the securities option "is available by reason of an employment of that person or another person". Where this applies, the facts must be carefully considered to decide if there is a causal connection between the person's employment and the grant of the option.
2. By the deeming provision (set out in section 471(3) ITEPA) which broadly provides that a right or opportunity to acquire a securities option made available by a person's employer is treated for these purposes as available by reason of employment. This is subject to the narrow specific exemptions set out in the legislation (which were not relevant on the facts in Vermilion), namely where a right is made available by an individual and made in the normal course of domestic, family or personal relationships of that person.
Lord Hodge noted that the deeming provision "creates a bright line rule: if a person’s employer … provides the employee the right or opportunity to acquire a securities option, that right or opportunity is conclusively treated as having been made available by reason of the employment of that person."
As the deeming provision applied, it was not necessary to consider the meaning of "by reason of" employment. "Vermilion, which at the relevant time was Mr Noble’s employer, made available to his nominee such an option. Vermilion’s reason for so doing is irrelevant when s 471(3) applies."
Analysis of the judgment
It is clear from the judgment that, when considering the employment-related securities legislation, the starting point is whether the deeming provision applies.
Lord Hodge stated that this "involves a straightforward examination of the agreement or transaction to ascertain who conferred the right or opportunity. The question is not concerned with the reason why the employer conferred the right or opportunity."
The judgment noted that the deeming provision should not be applied in a way that would produce unjust, absurd or anomalous results. The Supreme Court concluded that there was no such anomaly in in the case of Vermilion. It is possible that there may be attempts to run this argument in the future on different facts (although it is difficult to see how this would succeed).
It is only where the deeming provision does not apply that it is necessary to consider the causal test. The Supreme Court did not need to consider this on the facts of Vermilion. Given the way in which the legislation is drafted, it would seem that the causal test would come into play where the award was made to a former or future employee, rather than a current employee.
Osborne Clarke comment
After some uncertainty (following the earlier decision of the Court of Session in these proceedings in 2021), the Supreme Court decision clarifies the approach to interpreting the employment-related securities legislation.
The judgment contains a useful analysis of the purpose of the legislation and the deeming provision, and it is particularly relevant to any employers, directors and employees who may previously have been seeking to argue that a share award fell outside the scope of the employment income provisions.
Where an employer awards shares or options to an employee or director (including a non-executive director), the deeming provision brings them into the employment-related securities regime. The judgment clarifies that this is regardless of the employer's reasons for making the award.
The deeming provision, as decided by the Supreme Court, is therefore very wide ranging. So for example, it will be difficult to consider that any consultant who is a non-executive director and then receives an option or a share award will not fall within the employment-related securities regime. Likewise, the deeming rule could cause a security acquired by an LLP member or listed securities made available to an employee at the same time as to all shareholders being treated as employment related.
It is important that employers comply with their payroll obligations and include all such awards in their annual employment-related securities returns to HMRC.
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