First Tier Tribunal – Taxation of Share Options
Taxation of share options
In 2003, employment related shares and share options were made subject to wide sweeping reforms, specifically introduced to address tax avoidance. One such change was the introduction of a law that stated where an option to acquire shares is made available by an employer, or a person connected with the employer, in relation to a current and prospective employment, any taxable amount is treated as employment income in all instances. This ‘deeming’ provision also applies to officeholders.
From an adviser’s perspective, the deeming provision is clear – if you are caught by this provision any gain made on exercise is taxed to income tax and potentially National Insurance. However, the application of the deeming provision to the exercise of an option by an officeholder has been successfully challenged in a First Tier Tribunal hearing in the case of Vermilion Holdings Ltd v HMRC  UKFTT 230 (8 April 2019), much to the surprise of share scheme practitioners and no doubt HM Revenue & Customs! In RM2’s view, the decision is very likely to be appealed. Companies granting options or awarding shares to officeholders – should take advice on the tax implications.
Summary of the facts
In 2005 a potential investor in Vermillion approached Mr Noble, a corporate mergers and acquisition adviser. At the time the business was performing poorly and in 2006 Vermillion undertook an equity fundraising. Mr Noble’s company acted as an adviser on this transaction alongside Dickson Minto, who provided the legal advice. To meet the cost of their fees, Mr Noble’s company (owned 50:50 with another shareholder) and Dickson Minto were granted ‘Supplier Options’ such that each party could acquire 2.5% of the issued share capital in Vermillion on exercise.
By the end of 2006, Vermillion was again in financial difficulty and a rescue plan was devised. In 2007 it was agreed that Dickson Minto and Mr Noble’s companies would amend the terms of their Supplier Options. The consortium of investors also insisted that Mr Noble be appointed as Chairman to oversee the implementation of the rescue plan.
On 16 March 2007, Mr Noble became an officeholder of Vermillion. On 2 July 2007, Mr Noble and Dickson Minto entered into new option agreements over F ordinary shares in Vermillion for 1.5% of the issue share capital, superseding the earlier Supplier Option agreements. In June 2016, just before completion of a sale of Vermillion, Mr Noble signed a novation agreement which released Mr Noble’s jointly owned company under the 2007 Option in favour of him personally, which he then exercised and sold the shares.
Arguments on appeal
HMRC took the view that the 2007 Option was caught by the deeming provision as Mr Noble was an officer at the time the option was granted to him, irrespective of the purpose of the option, ‘the facts support the conclusion that the 2007 option was employment related’.
However, Mr Noble’s legal counsel argued that he only held the 2007 Option because of the original Supplier Option and that ultimately the 2007 Option was granted in relation to the surrender of the Supplier Option awarded for consultancy services.
HMRC were clear in the hearing that ‘the function of the court is to interpret legislation, according to the express language of the statute’ and whether the 2007 Option was granted by reason of employment is a ‘factual test’ and it remains the case that Mr Nobles was an officeholder of Vermillion when he was granted an option ‘by reason’ of that employment.
Whilst the judge acknowledged that the ‘2007 option is caught by the clear meaning of a literal interpretation’ of the law, the judge took the view that an anomaly arises as Mr Noble’s directorship was not the cause of the grant of the 2007 Option, and that this anomaly leads to the injustice of higher taxation for Mr Noble!
The judge refers to Mangin (amongst other judgements) where ‘it is presumed that neither injustice nor absurdity was intended, and if the language admitted of an interpretation which would avoid it, that ought to be adopted.’ The judge considers that the application of the deeming provision in this case should be limited due to the absurdity arising, such that the grant of an option be ‘decoupled’ from the employment based on whether there is a ‘link between the employment and the opportunity’, which she did not consider was the case.
The judge went on to state that ‘the ambit of the deeming provision should be limited where the artificial assumption from deeming is at variance with the factual reason that gave rise to the right to acquire the option.’ This is despite the fact that the judge acknowledges that the Supplier Option was annulled and the 2007 Option was a separate agreement with different terms. In addition, the judge does not consider the fact that the novation agreement was signed in favour of Mr Noble, which you could argue further undermines the notion that the exercise of the 2007 Option was not employment related.
There is a high probability that HMRC will appeal this judgement on the basis that the deeming provision is not ambiguous and the question of whether it is fair or not is the matter in point.
Where companies are granting options and issuing shares to officeholders and employees they must always be mindful of the tax implications and the wide ranging tax avoidance legislation.
If you wish to discuss share incentives, and the requirement to file annual share scheme returns, please do get in touch on 0208 949 5522 or email email@example.com.