The recent Court of Session case of Vermilion Holdings v HMRC provides a useful line of reasoning to support the assertion that just because a securities option is granted by an employer to an employee, it is not necessarily granted ‘by reason of an employment’. The ‘employment related securities’ rules are wide-ranging, but the grant of options for shares and other securities may or may not be subject to income tax and National Insurance contributions as employment income.
Employment related securities
Specific tax legislation sets out the UK tax treatment of ERS. This legislation applies to shares, other securities such as loan notes and options over shares and other securities that are acquired by reason of an employment (employment for these purposes includes the holding of an office, eg a directorship). Broadly speaking, the ERS rules seek to charge income tax on any element of reward in relation to ERS; for instance, where an employee acquires shares the rules aim to tax the full value of the reward provided by the employer to the employee in providing those shares, including any shortfall in the price paid for them when compared with their market value at the time they are acquired. Where the ERS rules apply, the deemed value received by the employee will generally be subject to income tax, and employee’s and employer’s Class 1 NICs, accounted for through the PAYE system where the securities are readily convertible assets.
By reason of an employment
The legislation that applies specifically to identify securities options acquired by reason of an employment is widely drawn. It initially sets out that, ‘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’ is an ERS. It then adds a deeming provision, stating that a right or opportunity ‘made available by a person’s employer [or connected party], is to be regarded… as available by reason of an employment… unless the person… is an individual, and the right or opportunity is made available in the normal course of… domestic, family or personal relationships.’
Mr Noble had been granted share options by Vermilion Holdings in 2006 in payment for consultancy services as part of an equity raising exercise. At this point Mr Noble was neither an employee or director of the company and the options granted were therefore accepted as not being ERS. In 2007, the company suffered financial difficulty and, as part of its financial restructuring, it was agreed that the 2006 options would be cancelled and replaced with new 2007 options on different terms, with Mr Noble also being appointed a director of the company.
The question considered by the courts was whether the replacement options were subject to the deeming provision and therefore ERS, despite the original options not being acquired by reason of Mr Noble’s employment.
One in a Vermilion
The Court of Session concluded, on balance, that the grant of the replacement options was not intended to confer a benefit in relation to Mr Noble’s employment, but instead it was made in return for Mr Noble’s surrender of his existing 2006 options. The 2007 options were not made available by Vermilion in its capacity as his employer, they could not therefore be made available by reason of his employment, and the deeming provision was not engaged.
Providing an interesting insight into the Court’s interpretation of the legislation, Lord Malcolm agreed with the First-tier Tribunal’s finding that, where deeming rules such as the one considered in this case apply, their application should be limited to the extent needed to avoid injustice or absurdity. This interpretation appears to provide a wider argument that this and other deeming rules should not be applied to situations where the result would be absurd or unjust.
The case highlights the broad range of circumstances where HMRC may seek to tax securities or options as employment income. Whilst the facts in this case are unusual (although not entirely unlikely to be repeated), they provide a useful line of reasoning to support the assertion that options granted by an employer to an employee are not necessarily granted ‘by reason of an employment’, and an interesting insight into the Court’s interpretation of the legislation. We await to hear if HMRC will appeal the decision.
Whether securities are ERS is fundamental to ascertaining their tax treatment, and ultimately determining the correct employee and employer tax obligations. Where shares are ERS they commonly may be subject to payroll withholding including employee and employer NICs. In addition, the employer will have separate obligations to report events relating to ERS on an annual ERS return.
For more information, please get in touch with Joe Pickering or your usual RSM contact.